The Fiscal Cost of Financial Instability

Abstract

This paper presents an agent based model that investigates the possible outcomes of different fiscal and regulatory policies in a financially fragile economy. We analyse the consequences of the attempt by the government to counteract a downturn ignoring the debt dynamics as modelled by Fisher and Minsky. In particular we formulate an educated guess about the burden that the government and the taxpayer must bear when a bubble bursts, and its relationship with the extent of government intervention and the taxation system. We also evaluate the outcomes of possible alternatives or complementary regulatory policies. We model four different scenarios treating separately a tax on profits and a tax on private wealth and, for both of them, we specify two cases depending on whether the financial system is able to autonomously generate liquidity. Therefore we can assess the effect of endogenous money and endogenous credit on the different stabilization policies.

Keywords: financial fragility, agent based model, fiscal policy, public deficit

JEL Classification: E22, E32, E62