The Fiscal Multiplier in Small Open Economy: The Role of Liquidity Frictions

July 12, 2016

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Format: Chicago

Jasmin Sin. The Fiscal Multiplier in Small Open Economy: The Role of Liquidity Frictions, (USA: International Monetary Fund, 2016) accessed December 26, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

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.

Subject: Asset and liability management, Expenditure, Financial markets, Fiscal multipliers, Fiscal policy, Foreign exchange, International capital markets, Liquidity, Real exchange rates

Keywords: B. sensitivity analysis, Fiscal multipliers, Global, Government spending multiplier, Government spending shock, International capital markets, Liquidity, Liquidity crisis, Liquidity friction, Nominal interest rate, Real exchange rates, Small open economy, SOE-DEFK model, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/138
Stock No:

WPIEA2016138
ISBN:

9781498366298
ISSN:

1018-5941

Notes

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