Working Paper: NBER ID: w10532
Authors: Ricardo Caballero; Arvind Krishnamurthy
Abstract: 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: No keywords provided
JEL Codes: E44; E62; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of financial depth in emerging markets (F65) | greater crowding out of private investment during fiscal expansions (E62) |
| government debt increases (H63) | reduces liquidity available for private investment (O16) |
| crowding out effect during crises (F65) | exceeds one (Y60) |
| financial depth (O16) | liquidity available to government and private sector (E44) |
| fiscal policy (E62) | private investment (E22) |
| fiscal policy is more procyclical in emerging economies (E62) | fiscal expansions do not have intended stimulative effect (E62) |
| dynamics of government debt and private investment during crises (H12) | differ significantly between emerging and advanced economies (O17) |
| fiscal policy in emerging markets (O23) | less effective and can be harmful during economic downturns (E65) |