The Fiscal Costs of Financial Instability Revisited

46 Pages Posted: 19 May 2003

See all articles by Felix Eschenbach

Felix Eschenbach

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Ludger Schuknecht

European Central Bank (ECB)

Date Written: November 2002

Abstract

This paper conducts a comprehensive analysis of the fiscal costs of financial instability (defined as major asset price changes and including, as extreme cases, financial crises). The study identifies three channels to fiscal accounts: 1) revenue effects on capital gains, asset turnover and consumption tax, 2) bailout costs as asset price declines undermine balance sheets of companies/banks, and 3) second-round effects from asset prices changes via the real economy and via debt service costs. A panel analysis and case studies show that episodes of financial instability increase the variability of fiscal balances. Moreover, fiscal costs are often very large and much larger than assumed in the literature so far with public debt rising by up to 50% of GDP during episodes. These fiscal effects can also serve as a, so far under-emphasised, rationale for the deficit and debt targets in the EU's Maastricht Treaty and Stability and Growth Pact.

Keywords: Fiscal policies, deficits, asset prices, financial stability, financial crisis

JEL Classification: H3, H6, E6

Suggested Citation

Eschenbach, Felix and Schuknecht, Ludger, The Fiscal Costs of Financial Instability Revisited (November 2002). Available at SSRN: https://ssrn.com/abstract=358441 or http://dx.doi.org/10.2139/ssrn.358441

Felix Eschenbach

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

Burgemeester Oudlaan 50
3062 PA Rotterdam, NL 3062 PA
Netherlands
+31 10 408 8924 (Phone)
+31 10 408 9146 (Fax)

Ludger Schuknecht (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6494 (Phone)
+49 69 1344 7809 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
166
Abstract Views
1,615
rank
253,318
PlumX Metrics