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Financial Fragility and the Fiscal Multiplier

Author

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  • Sweder van Wijnbergen

    (University of Amsterdam)

  • Christiaan van der Kwaak

    (University of Amsterdam)

Abstract

We investigate the effectiveness of fiscal stimuli when banks are undercapitalized and have large holdings of government bonds subject to sovereign default risk. Deficit-financed government purchases then crowd out private expenditure and fiscal multipliers can turn negative. Crowding out increases for longer maturity bonds and higher sovereign default risk. We estimate a DSGE model with financial frictions for Spain and find that investment crowding out indeed leads to a negative cumulative fiscal multiplier. When monetary policy is exogenous, like at the ZLB or in a currency union, fiscal stimuli become more effective but multipliers are reduced when banks are undercapitalized.

Suggested Citation

  • Sweder van Wijnbergen & Christiaan van der Kwaak, 2014. "Financial Fragility and the Fiscal Multiplier," Tinbergen Institute Discussion Papers 14-004/VI/DSF70, Tinbergen Institute, revised 19 Sep 2017.
  • Handle: RePEc:tin:wpaper:20140004
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    File URL: https://papers.tinbergen.nl/14004.pdf
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    Cited by:

    1. Strobel, Felix, 2018. "The government spending multiplier, fiscal stress, and the zero lower bound," Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181531, Verein fĂĽr Socialpolitik / German Economic Association.
    2. Yu, Sherry, 2017. "Sovereign and bank Interdependencies—Evidence from the CDS market," Research in International Business and Finance, Elsevier, vol. 39(PA), pages 68-84.

    More about this item

    Keywords

    Financial Intermediation; Macrofinancial Fragility; Fiscal Policy; Sovereign Default Risk;

    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
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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