Wemodel macroeconomic instability as the outcomeof the dynamic interaction between debt accumulation and the “state of confidence” in a small open economy with a super-fixed exchange-rate arrangement. We use a system dynamic approach and show that instability is a likely feature when macroeconomic behaviour is characterized by out-of-equilibrium dynamics with balance-sheet effects and deviation amplifying expectation formation rules that interact endogenously. We address the issue of the macroeconomic stabilization puzzle and carry out a quantitative evaluation based on sensitivity analysis with reference to Argentina, during the currency-board arrangement. We find that a tight fiscal policy is likely to be destabilizing inasmuch as it adds to the fall in expenditure, output and the “state of confidence”. On the other side, a traditional monetary policy can fail in switching off macroeconomic instability if the reduction in interest rates does not compensate for the fall in the “state of confidence”, whilst a direct stimulus to aggregate expenditure is required to avoid an economic collapse.
Wemodel macroeconomic instability as the outcomeof the dynamic interaction between debt accumulation and the “state of confidence” in a small open economy with a super-fixed exchange-rate arrangement. We use a system dynamic approach and show that instability is a likely feature when macroeconomic behaviour is characterized by out-of-equilibrium dynamics with balance-sheet effects and deviation amplifying expectation formation rules that interact endogenously. We address the issue of the macroeconomic stabilization puzzle and carry out a quantitative evaluation based on sensitivity analysis with reference to Argentina, during the currency-board arrangement. We find that a tight fiscal policy is likely to be destabilizing inasmuch as it adds to the fall in expenditure, output and the “state of confidence”. On the other side, a traditional monetary policy can fail in switching off macroeconomic instability if the reduction in interest rates does not compensate for the fall in the “state of confidence”, whilst a direct stimulus to aggregate expenditure is required to avoid an economic collapse.
State of confidence, overborrowing and macroeconomic stabilization in out-of-equilibrium dynamics / Cavallaro, Eleonora; Maggi, Bernardo. - In: ECONOMIC MODELLING. - ISSN 0264-9993. - ELETTRONICO. - 59:(2016), pp. 210-223.
State of confidence, overborrowing and macroeconomic stabilization in out-of-equilibrium dynamics
CAVALLARO, Eleonora
;MAGGI, Bernardo
2016
Abstract
Wemodel macroeconomic instability as the outcomeof the dynamic interaction between debt accumulation and the “state of confidence” in a small open economy with a super-fixed exchange-rate arrangement. We use a system dynamic approach and show that instability is a likely feature when macroeconomic behaviour is characterized by out-of-equilibrium dynamics with balance-sheet effects and deviation amplifying expectation formation rules that interact endogenously. We address the issue of the macroeconomic stabilization puzzle and carry out a quantitative evaluation based on sensitivity analysis with reference to Argentina, during the currency-board arrangement. We find that a tight fiscal policy is likely to be destabilizing inasmuch as it adds to the fall in expenditure, output and the “state of confidence”. On the other side, a traditional monetary policy can fail in switching off macroeconomic instability if the reduction in interest rates does not compensate for the fall in the “state of confidence”, whilst a direct stimulus to aggregate expenditure is required to avoid an economic collapse.File | Dimensione | Formato | |
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