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HOW COSTLY ARE BORROWING COSTS? AN ANALYSIS OF ALTERNATIVE FISCAL POLICIES DURING CRISES

Published online by Cambridge University Press:  05 October 2015

Inci Gumus
Inci Gumus*
Affiliation:
Sabanci University
*
Address correspondence to: Inci Gumus, Faculty of Arts and Social Sciences, Sabanci University, Orhanli, Tuzla, 34956, Istanbul, Turkey; e-mail: incigumus@sabanciuniv.edu.
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Abstract

Financial crises lead to substantial declines in output and consumption in emerging markets. The fact that fiscal policy is procyclical in these countries shows that the effects of a crisis are exacerbated by spending cuts and tax increases, which are usually attributed to borrowing constraints they face in bad times. This paper quantitatively analyzes the costs of reduced borrowing during crises by studying the effects of expansionary fiscal policies that would have been possible to implement, had the government been able to borrow more. The model shows that a 25% reduction of taxes on labor income, capital income, and consumption during the 1997 Korean crisis would have required an additional borrowing of 4.10% of GDP, while increasing output and consumption by 5.23 and 5.92 percentage points, respectively. When the effects of each tax rate are analyzed separately, labor tax reduction turns out to be more effective than the other policies.

Keywords

Fiscal PolicyFinancial CrisesBusiness Cycle Fluctuations
Type
Articles
Information
Macroeconomic Dynamics , Volume 21 , Special Issue 5: Recent Topics in Computational Macroeconomics , July 2017 , pp. 1141 - 1157
Copyright
Copyright © Cambridge University Press 2015 

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Footnotes

I would like to thank the participants at the Midwest Macroeconomics Conference (Nashville, 2011), the IEA Sixteenth World Congress (Beijing, 2011), the SNDE Conference (Istanbul, 2012), the ICMAIF Conference (Rethymno, 2013), and the third ISCEF (Paris, 2014) and two anonymous referees for helpful comments. Financial support from the Scientific and Technological Research Council of Turkey (TUBITAK, Grant 111K431) is also gratefully acknowledged. All errors are my own.

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