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Fiscal Policy and Financial Depth

Author

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  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Abstract

Most economists and observers place the lack of fiscal discipline at the core of the recent Argentine crisis. This begs the question of how countries like Belgium or Italy (pre-Maastricht) could run large fiscal deficits and accumulate debts far beyond those of Argentina, without experiencing crises nearly as dramatic as that of Argentina? Why is it that Argentina cannot act like Belgium or Italy and pursue expansionary fiscal policy during downturns? We argue that advanced and emerging economies differ in their financial depth, and show that lack of financial depth constrains fiscal policy in a way that can overturn standard Keynesian fiscal policy prescriptions. We also provide empirical support for this viewpoint. Crowding out is systematically larger in emerging markets than in developed economies. More importantly, this difference is extreme during crises, when the crowding out coefficient exceeds one in emerging market economies.

Suggested Citation

  • Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Fiscal Policy and Financial Depth," NBER Working Papers 10532, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10532
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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