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

IMF Working Papers, July 12, 2016

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

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Bibliographic details

• Authors: Jasmin Sin
• Published: July 12, 2016
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781498366298.001

Summary

• Author: Jasmin Sin
• Date: July 12, 2016
• Type: IMF Working Paper (Working Paper No. 2016/138)
• Core result: The fiscal multiplier is large when frictions are present in domestic and international financial markets.

Model and Mechanism

• Framework: small-open-economy DSGE model enriched with financial frictions (SOE-DEFK model referenced in Keywords).
• Key model assumptions and channel:
  • Government bonds are more liquid than private financial assets.
  • Entrepreneurs face liquidity constraints.
  • A bond-financed fiscal expansion eases entrepreneurs' liquidity constraints.
  • Eased liquidity constraints stimulate investment and hence growth.
• Boundary condition where mechanism fails:
  • The mechanism breaks down under the assumption of perfect international capital mobility.
  • Conventional models that ignore frictions in international capital markets tend to underestimate the fiscal multiplier.

Main Findings

• Fiscal multiplier magnitude:
  • The multiplier is large when frictions exist in both domestic and international financial markets.
• Comparative insight:
  • Models assuming perfect international capital mobility understate the fiscal multiplier relative to models with international liquidity frictions.

Policy Implications

• Recognition of international financial frictions:
  • Policy assessments of fiscal stimulus should account for frictions in international capital markets to avoid underestimating the multiplier.
• Financing composition matters:
  • Bond-financed fiscal expansions can have stronger effects on investment and growth when government bonds provide liquidity relief to constrained entrepreneurs.

Key statistics and publication identifiers

• Pages: 34
• Volume: 2016
• Issue: 138
• Series: Working Paper No. 2016/138
• DOI: https://doi.org/10.5089/9781498366298.001
• Stock No: WPIEA2016138
• ISBN: 9781498366298
• ISSN: 1018-5941

Source: The Fiscal Multiplier in Small Open Economy: The Role of Liquidity Frictions, Jasmin Sin, IMF Working Papers, July 12, 2016.

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