Fiscal Buffers, Private Debt and Recession: The Good, the Bad and the Ugly

59 Pages Posted: 9 Jul 2019

See all articles by Nicoletta Batini

Nicoletta Batini

International Monetary Fund (IMF)

Giovanni Melina

International Monetary Fund (IMF)

Stefania Villa

Bank of Italy

Date Written: July 20, 2018

Abstract

Focusing on Euro-Area countries, we show empirically that higher private debt leads to deeper recessions while higher public debt does not, unless its level is especially high. We then build a general equilibrium model that replicates these dynamics and use it to design a policy that can mitigate the recessionary consequences of private deleveraging. In the model, in the aftermath of financial shocks, recessions are milder and public debt is more contained when the government lends directly to those households and firms that face binding borrowing constraints. As a consequence, large fiscal buffers are critical to enhance macroeconomic resilience to financial shocks.

Keywords: private debt, public debt, financial crisis, financial shocks, borrowing constraints, fiscal limits

JEL Classification: E44, E62, H63

Suggested Citation

Batini, Nicoletta and Melina, Giovanni and Villa, Stefania, Fiscal Buffers, Private Debt and Recession: The Good, the Bad and the Ugly (July 20, 2018). Bank of Italy Temi di Discussione (Working Paper) No. 1186, July 2018. Available at SSRN: https://ssrn.com/abstract=3210782 or http://dx.doi.org/10.2139/ssrn.3210782

Nicoletta Batini

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Giovanni Melina

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Stefania Villa (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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