Kirchner, M. and van Wijnbergen, S. (2016). Fiscal Deficits, Financial Fragility, and the Effectiveness of Government Policies Journal of Monetary Economics, 80:51--68.

Recent developments in the euro area highlighted the interactions between fiscal policy, sovereign debt and financial fragility. We introduce asset choice and sovereign debt holdings in banks{\textquoteright} portfolios in an otherwise standard macroeconomic model with financial frictions, to emphasize a new crowding-out mechanism through reduced private access to credit when leverage-constrained banks accumulate sovereign debt. When banks are substantially invested in sovereign debt, the effectiveness of fiscal stimuli is impaired because deficit-financed fiscal expansions through this channel crowd out private demand. This channel also significantly reduces the gains from fiscal policy when interest rates are at the Zero Lower Bound.