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Tackling the fiscal policy-financial stability nexus

Author

Listed:
  • Claudio Borio
  • Marc Farag
  • Fabrizio Zampolli

Abstract

Tackling the fiscal policy-financial stability nexus is essential to ensure financial and hence macroeconomic stability. In this paper, we review the literature on this topic and suggest how policy could best tackle the link. Doing so involves action on two fronts. First, incorporating financial stability considerations in the design of fiscal policy. This means, in particular, considering the risk of financial crises when assessing fiscal space, recognising the flattering effects of financial booms on fiscal positions and removing or reducing fiscal incentives to private debt accumulation. Second, acknowledging that domestic currency-denominated public debt is not fully risk-free in the design of the prudential regulation of financial institutions. This calls for carefully balanced risk-sensitive capital charges or other measures to limit banks' sovereign exposures with due regard to the special role of government bonds in the financial system and country-specific characteristics. That said, prudent regulation cannot substitute for fiscal prudence.

Suggested Citation

  • Claudio Borio & Marc Farag & Fabrizio Zampolli, 2023. "Tackling the fiscal policy-financial stability nexus," BIS Working Papers 1090, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1090
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    More about this item

    Keywords

    financial crises; doom loops; sovereign exposures; prudential policy; fiscal policy;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • H1 - Public Economics - - Structure and Scope of Government
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • H8 - Public Economics - - Miscellaneous Issues

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