Foreign currency denominated indebtedness and the fiscal multiplier

Mercredi | 2017-09-06
B103 12h

Marie-Pierre HORY – Grégory LEVIEUGE – Daria ONORI

After presenting an empirical evidence of the negative impact of foreign denominated debt on the fiscal multiplier, this paper develops a two-country DSGE model with sticky prices, imperfect and incomplete international financial markets and a financial accelerator à la Bernanke et al. 1999. Following an increase in public spending, the real exchange rate depreciates. In the case where firms are indebted in foreign currency, the depreciation leads to an increase in the value of firms’ debt ratios. The financing costs therefore increase, generating a decrease in the investment level. The positive impact of fiscal policy becomes thus weaker. In contrast, if firms are indebted in local currency, the depreciation amplifies the positive impact of fiscal policy. This result supports the increasing number of measures taken in EMEs to limit their level of indebtedness in foreign currency.