Fiscal Multipliers with Financial Fragmentation Risk and Interactions with Monetary Policy

49 Pages Posted: 13 Jun 2020

See all articles by Matthieu Darracq Paries

Matthieu Darracq Paries

European Central Bank (ECB)

Niki Papadopoulou

Central Bank of Cyprus

Georg Müller

affiliation not provided to SSRN

Date Written: June, 2020

Abstract

We quantify the size of fiscal multipliers under financial fragmentation risk and demonstrate how non-standard monetary policy can support the macroeconomic transmission of fiscal interventions. We employ a DSGE model with financial frictions whereby the interplay of corporate, banks and sovereign solvency risk affect the transmission of fiscal policy. The output multiplier of fiscal expansion is found to be significantly dampened by tighter financial conditions in case households are less certain about implicit and explicit state-guarantees for the banking system, or banks are weakly capitalized and highly exposed to the government sector. In this context, we show that central bank asset purchases or liquidity operations designed to ensure favourable bank funding conditions can restore fiscal multipliers.

Keywords: DSGE models, fiscal stabilization, sovereign-bank nexus, sovereign risk

JEL Classification: E44, E52, E62

Suggested Citation

Darracq Paries, Matthieu and Papadopoulou, Niki and Müller, Georg, Fiscal Multipliers with Financial Fragmentation Risk and Interactions with Monetary Policy (June, 2020). ECB Working Paper No. 20202418, Available at SSRN: https://ssrn.com/abstract=3625534

Matthieu Darracq Paries (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+496913446631 (Phone)
+496913447604 (Fax)

Niki Papadopoulou

Central Bank of Cyprus ( email )

80 Kennedy Ave
1076 Nicosia
Cyprus

Georg Müller

affiliation not provided to SSRN

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