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Fiscal Space and the Aftermath of Financial Crises: How It Matters and Why

Author

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  • Christina D. Romer

    (University of California, Berkeley)

  • David H. Romer

    (University of California, Berkeley)

Abstract
In a sample of 30 countries during the period 1980-2017, those with lower debt-to-GDP ratios responded to financial distress with much more expansionary fiscal policy and suffered much less severe aftermaths. Two lines of evidence together suggest that the relationship between the debt ratio and the policy response is driven partly by problems with sovereign market access, but even more so by the choices made by domestic and international policymakers. First, although there is some relationship between more direct measures of market access and the fiscal response to distress, incorporating the direct measures attenuates only slightly the link between the debt ratio and the policy response. Second, contemporaneous accounts of the policymaking process in episodes of major financial distress show a number of cases where shifts to austerity were driven by problems with market access, but show at least as many where the shifts resulted from policymakers' choices despite an absence of difficulties with market access. These results point to a twofold message: conducting policy in normal times to maintain fiscal space provides valuable insurance in the event of a financial crisis, and domestic and international policymakers should not let debt ratios unnecessarily determine the response to a crisis.

Suggested Citation

  • Christina D. Romer & David H. Romer, 2019. "Fiscal Space and the Aftermath of Financial Crises: How It Matters and Why," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 50(1 (Spring), pages 239-331.
    • Handle: RePEc:bin:bpeajo:v:50:y:2019:i:2019-01:p:239-331
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    References listed on IDEAS

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    More about this item

    Keywords

    fiscal policy; global financial crisis; debt ratio;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G01 - Financial Economics - - General - - - Financial Crises
    • N10 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - General, International, or Comparative
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative

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