The Fiscal Multiplier in Small Open Economy: The Role of Liquidity Frictions
Electronic Access:
Free Download. Use the free Adobe Acrobat Reader to view this PDF file
Summary:
This paper studies the fiscal multiplier using a small-open-economy DSGE model enriched with financial frictions. It shows that the multiplier is large when frictions are present in domestic and international financial markets. The reason is that in the model government bonds are more liquid than private financial assets and that entrepreneurs face liquidity constraints. A bond-financed fiscal expansion eases these constraints and stimulates investment and hence growth. This mechanism, however, breaks down under the assumption of perfect international capital mobility, suggesting that conventional models which ignore the presence of frictions in international capital markets tend to underestimate the fiscal multiplier.
Series:
Working Paper No. 2016/138
Subject:
Asset and liability management Expenditure Financial markets Fiscal multipliers Fiscal policy Foreign exchange International capital markets Liquidity Real exchange rates
Notes:
English
Publication Date:
July 12, 2016
ISBN/ISSN:
9781498366298/1018-5941
Stock No:
WPIEA2016138
Pages:
34
Please address any questions about this title to publications@imf.org