THE EFFECTS OF FINANCIAL CRISIS ON FISCAL POSITIONS
Bank of Greece
The recent financial crisis was characterized by the sizeable fiscal cost of banking sector bail out operations and the significant automatic and discretionary fiscal policy response to shrinking output, which have put increased pressure on public finances in many industrialized countries. This paper tries to evaluate the impact of financial crisis episodes on debt developments. The findings indicate that severe financial crisis episodes increase the stock of debt by 2.7%-4.0% of GDP, on average in the 20 OECD countries examined. Ιn countries with big financial sectors it ranges from 4.2%-5.3% of GDP and in countries with smaller financial sectors it is about 1.4%-1.7% of GDP. The primary balance and the cyclically adjusted fiscal policy stance ease by about 2.6% of GDP and 1.6% of potential GDP, respectively, in the event of a severe financial market crash. Expansionary fiscal interventions are more pronounced in countries with sizable financial sectors. I find significant evidence that a financial market collapse paves the way for a subsequent deterioration in debt ratios.
Keywords: fiscal policy, public debt, financial market, crisis, credit.
JEL classification: E61, E62, H61, H62, H63, E32.
Acknowledgments: I would like to thank Jakob de Haan, Arye L. Hillman, Heinrich W. Urspung, as well as Heather Gibson, Panagiotis Konstantinou and Maria Kasselaki for their useful comments and suggestions. The views of the paper are my own and do not necessarily reflect those of the Bank of Greece. All remaining errors are mine.
Economic Research Department, Bank of Greece,
21 El. Venizelos Av. 10250 Athens, Greece