Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/336471 
Year of Publication: 
2025
Series/Report no.: 
Working Papers No. 2025-12
Publisher: 
Banco de México, Ciudad de México
Abstract: 
This paper provides empirical evidence on the balance sheet channel of fiscal policy in peripheral European economies. Our findings using a Panel VAR, reveal that shifts in financial institutions' balance sheets following a debt-financed fiscal expansion, reduce credit provision and investment in these countries. Moreover, the analysis indicates that economies with higher sovereign exposure experienced higher credit crunches and investment declines. To explore the underlying mechanisms, we estimate a DSGE model that incorporates banks as primary holders of sovereign debt. The model shows that sovereign exposure amplifies the negative effects on credit supply, lowering investment and capital formation. A counterfactual scenario without bank-held sovereign bonds isolates the contribution of the balance sheet channel: removing this channel weakens the crowding-out effect, with investment falling 0.2 percentage points less and output increasing by 0.02 percentage points more. These effects appear stronger during the financial and sovereign debt crises.
Subjects: 
SVAR
DSGE
Bayesian estimation
Fiscal policy
Sovereign debt
Credit
Euro Area
JEL: 
C11
E32
E44
E62
H63
Document Type: 
Working Paper
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