Working Paper: NBER ID: w23931
Authors: Christina D. Romer; David H. Romer
Abstract: Analysis based on a new measure of financial distress for 24 advanced economies in the postwar period shows substantial variation in the aftermath of financial crises. This paper examines the role that macroeconomic policy plays in explaining this variation. We find that the degree of monetary and fiscal policy space prior to financial distress—that is, whether the policy interest rate is above the zero lower bound and whether the debt-to-GDP ratio is relatively low—greatly affects the aftermath of crises. The decline in output following a crisis is less than 1 percent when a country possesses both types of policy space, but almost 10 percent when it has neither. The difference is highly statistically significant and robust to the measures of policy space and the sample. We also consider the mechanisms by which policy space matters. We find that monetary and fiscal policy are used more aggressively when policy space is ample. Financial distress itself is also less persistent when there is policy space. The findings may have implications for policy during both normal times and periods of acute financial distress.
Keywords: macroeconomic policy; financial crises; policy space
JEL Codes: E32; E52; E62; G01; N10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary and fiscal policy space (E63) | Decline in output following a financial crisis (G01) |
| Monetary policy space (E52) | Aggressive use of monetary policy (E63) |
| Policy space (R28) | Financial distress persistence (G33) |
| Financial distress (G33) | Economic outcomes (F69) |