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On the Recovery Path during a Liquidity Trap: Do Financial Frictions Matter for Fiscal Multipliers?

Author

Listed:
  • Julio A. CARRILLO

    () (Ghent University)

  • Celine POILLY

    () (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

Abstract

This paper investigates the effects of a fiscal stimulus when financial frictions and a liquidity trap are present. These two conditions make a government spending expansion and a reduction in capital income taxes more efficient in stimulating output. In contrast, a reduction in labor income taxes may aggravate the economic conditions. In addition, small implementation delays in government spending may result in big spending multipliers in the short run. All of these results rely partly on the dynamic interaction between inflation and the external finance premium. Lastly, simulations of the ARRA stimulus package predict that the output gains due to the presence of financial frictions may lie between 1.3 % and 2.5 % of GDP.

Suggested Citation

  • Julio A. CARRILLO & Celine POILLY, 2010. "On the Recovery Path during a Liquidity Trap: Do Financial Frictions Matter for Fiscal Multipliers?," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2010034, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  • Handle: RePEc:ctl:louvir:2010034
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    File URL: http://sites.uclouvain.be/econ/DP/IRES/2010034.pdf
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    References listed on IDEAS

    as
    1. Stepahnie Schmitt-Grohé & Martín Uribe, 2007. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 5, pages 125-186 Central Bank of Chile.
    2. Queijo von Heideken, Virginia, 2008. "How Important are Financial Frictions in the U.S. and the Euro Area?," Working Paper Series 223, Sveriges Riksbank (Central Bank of Sweden).
    3. Frederic S. Miskin & Klaus Schmidt-Hebbel, 2007. "Monetary Policy under Inflation Targeting: An Introduction," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 1, pages 001-022 Central Bank of Chile.
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    Citations

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    Cited by:

    1. Stefanie Flotho, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Discussion Paper Series 20, Department of International Economic Policy, University of Freiburg, revised Jun 2012.
    2. Javier Andrés & José Emilio Boscá & Javier Ferri, 2011. "Household Leverage and Fiscal Multipliers," Working Papers 1103, International Economics Institute, University of Valencia.
    3. Flotho, Stefanie, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62028, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    Zero Lower Bound; Financial Accelerator; Fiscal Policy;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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