Fiscal policy and financial depth
By: Ricardo J. Caballero [and] Arvind Krishnamurthy
Contributors: Massachusetts Institute of Technology. Dept. of Economics; Krishnamurthy, Arvind
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 04-22; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 04-22.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2004
Place of publication: Cambridge, MA
Language: eng
Number of pages: 20
Description: Most economists and observers place the lack of fiscal discipline at the core of the recent Argentine crisis. This begs the question of how countries like Belgium or Italy (pre-Maastricht) could run large fiscal deficits and accumulate debts far beyond those of Argentina, without experiencing crises nearly as dramatic as that of Argentina. Why is it that Argentina cannot act like Belgium or Italy and pursue expansionary fiscal policy during downturns? We argue that advanced and emerging economies differ in their financial depth, and show that lack of financial depth constrains fiscal policy in a way that can overturn standard Keynesian fiscal policy prescriptions. We also provide empirical support for this viewpoint. Crowding out is systematically larger in emerging markets than in developed economies. More importantly, this difference is extreme during crises, when the crowding out coefficient exceeds one in emerging market economies. Keywords: sudden stops, financial depth, fiscal deficits, liquidity crises, populism, crowding out. JEL Classifications: E44, E62, F34, F41.
Notes: "May 3, 2004."

Includes bibliographical references (p. 19-20).

Abstract in HTML and working paper for download in PDF available via World Wide Web at the Social Science Research Network.