Is fiscal expansion more effective in a financial crisis?

ABSTRACT

After the Great Recession, the Keynesian expansionary policy has been regarded as an effective measure, especially under imperfect financial market conditions. Among literature related to fiscal policy in financial crises, Fernández-Villaverde (2010) suggests that the fiscal policy multiplier increases in a financial crisis through the Fisher effect. However, we should note that the author simply compared the multiplier computed in the standard new Keynesian dynamic stochastic general equilibrium (DSGE) with that in the DSGE with financial accelerator settings. As the financial accelerator is considered effective during both financial crises and normal financial conditions, the author’s comparison should be considered insignificant for showing a greater multiplier in the financial crisis. In this study, to make the exact comparison, we first estimate parameters regarding the Fisher effect under each regime separately and then compute and compare the estimated fiscal multipliers using these 2 estimates in the same DSGE model. Using Japanese financial data that provide enough observations under the good and bad regimes of financial conditions, we find that fiscal multipliers are smaller in the bad regime than in the good regime.

KEYWORDS:

• Fiscal policy
• financial friction
• DSGE
• Japanese economy

JEL CLASSIFICATION:

• E62
• H30
• H50

Acknowledgments

We are grateful to Kazuki Hiraga and the participants of the Kansai Public Economics Workshop 2016, Osaka, Japan, for their helpful comments. This work was supported by the Japan Society for the Promotion of Science (Grant-in-Aid for Scientific Research #15H03356). The authors are responsible for any errors in the text.

Disclosure statement

No potential conflict of interest was reported by the authors.​​​

Notes

¹ This phenomenon prevents the entrepreneurs from purchasing capital by their own net worth alone.

² is a technical term; new entrepreneurs need funds for investment. Thus, they receive money from the ones who leave the economy. Since is sufficiently large to mitigate the effect of , we omit the transfer in the equation. However, doing so does not affect our main results.

³ Details are upon the request.

⁴ Based on Ramsey Regression Equation Specification Error Test, using the second powers of fitted values, we can say that there is no omitted variable problem ( with p-value ).

⁵ See Note: 3 in Table 1 for the definitions of the regimes.

Additional information

Funding

This work was supported by the Japan Society for the Promotion of Science (Grant-in-Aid for Scientific Research) [16H03637].