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  • P-ISSN 2586-2995
  • E-ISSN 2586-4130
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KDI Journal of Economic Policy. Vol. 44, No. 3, August 2022, pp. 49-74

https://doi.org/10.23895/kdijep.2022.44.3.49

× KDI Open Access is a program of fully open access journals to facilitate the widest possible dissemination of high-quality research. All research articles published in KDI JEP are immediately, permanently and freely available online for everyone to read, download and share in terms of the Creative Commons Attribution 4.0 International License.

Effects of Fiscal Instability on Financial Instability†

SUNJOO HWANG

Author & Article History

Manuscript received 02 February 2022; revision received 02 March 2022; accepted 09 April 2022.

Abstract

This paper empirically examines how fiscal instability affects financial instability. According to an IMF forecast (2021a), the fiscal space in Korea will be steadily reduced in the future. The theoretical literature predicts that if fiscal stability is undermined, financial stability will also be in danger given that government guarantees on banks are weakened and/or sovereign bonds held in banks become riskier. This paper empirically finds the existence of this negative impact of fiscal instability on financial instability. I also find that the intensity of this fiscal-financial relationship is greater in a country where (i) its currency is not a reserve currency such as the US dollar or euro, (ii) its banking sector is large relative to government sector, and/or (iii) its private credit to GDP is high. Korea has all of these three characteristics and hence needs to put more effort into maintaining fiscal stability.

Keywords

Fiscal Instability, Financial Instability, Sovereign Bond, Implicit Government Guarantees, Noncore Currency

JEL Code

G01, G21, H60

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