Fiscal policy design in collateral-constraint economies: The role of commitment

Abstract

I study the optimal design of fiscal policy, with and without commitment, in collateral-constraint models where the households’ borrowing capacity is linked to the economy’s real exchange rate. When the collateral constraint is binding, increasing public spending raises the real exchange rate and stabilizes private consumption. However, by making potential crises less costly, higher spending also makes borrowing more attractive. I show that the Ramsey-optimal policy entails a commitment to restrict fiscal stimulus during crisis periods, aimed at deterring excessive debt accumulation. In a quantitative application to Argentina, I show that, despite the potential for substantial ex-post gains from stabilizing the real exchange rate, significant fiscal expansions are not optimal because of the borrowing inefficiency.