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Title:Fiscal deficits, financial fragility, and the effectiveness of government policies PDF Logo
Authors:Kirchner, Markus
van Wijnbergen, Sweder
Issue Date:2012
Series/Report no.:Discussion Paper, Deutsche Bundesbank 20/2012
Abstract:Recent macro developments in the euro area have highlighted the interactions between fiscal policy, sovereign debt, and financial fragility. We take a structural macroeconomic model with frictions in the financial intermediation process, in line with recent research, but introduce asset choice and sovereign debt holdings in the portfolio of banks. Using this model, we emphasize a new crowding-out mechanism that works through reduced private access to credit when banks accumulate sovereign debt under a leverage constraint. Our results show that, when banks invest a substantial fraction of their assets in sovereign debt, the effectiveness of fiscal stimulus policies may be impaired because deficit-financed fiscal expansions may tighten financial conditions to such an extent that private demand is crowded out. We also analyze the macroeconomic effectiveness of liquidity support to commercial banks through recapitalizations or loans by the government and the impact of different ways of financing those policies.
Subjects:financial intermediation
fiscal policy
sovereign debt
JEL:E44
E62
H30
ISBN:978-3-86558-834-0
Document Type:Working Paper
Appears in Collections:Discussion Papers, Deutsche Bundesbank

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