Financial Fragility and the Keynesian Multiplier

100 Pages Posted: 30 Oct 2017

See all articles by Christiaan van der Kwaak

Christiaan van der Kwaak

University of Groningen

Sweder van Wijnbergen

Universiteit van Amsterdam; Tinbergen Institute; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: October 2017

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.

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

JEL Classification: E44, E62, H30

Suggested Citation

van der Kwaak, Christiaan and van Wijnbergen, Sweder, Financial Fragility and the Keynesian Multiplier (October 2017). CEPR Discussion Paper No. DP12394. Available at SSRN: https://ssrn.com/abstract=3061827

Christiaan Van der Kwaak (Contact Author)

University of Groningen ( email )

P.O. Box 800
9700 AH Groningen, Groningen 9700 AV
Netherlands

Sweder Van Wijnbergen

Universiteit van Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4011 / 4203 (Phone)
+31-35-624 91 82 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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