State of confidence,overborrowing and macroeconomic stabilization in out-of-equilibrium dynamics |
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Institution: | 1. Department of Economics and Law, Faculty of Economics, Sapienza University of Rome, Via del Castro Laurenziano, 9, 00161, Rome, Italy;2. Department of Statistical Sciences, Faculty of Engineering of Information, Informatics and Statistics, Sapienza University of Rome, Piazzale Aldo Moro, 5, 00185 Rome, Italy;1. Department of Economics “Marco Biagi”, Viale Berengario 51, 41121 Modena, Italy;2. Department of Economics “Marco Biagi” and ReCent, Viale Berengario 51, 41121 Modena, Italy |
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Abstract: | We model macroeconomic instability as the outcome of 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. |
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