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Can Fiscal Policy Stimulus Boost Economic Recovery?

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  • Luca Agnello
  • Ricardo M. Sousa

Abstract

We assess the role played by fiscal policy in explaining the dynamics of asset markets. Using a panel of ten industrialized countries, we show that a positive fiscal shock has a negative impact in both stock and housing prices. However, while stock prices immediately adjust to the shock and the effect of fiscal policy is temporary, housing prices gradually and persistently fall. Consequently, the attempts of fiscal policy to mitigate stock price developments (e.g. via taxes on capital gains) may severely de-stabilize housing markets. The empirical findings also point to significant fiscal multiplier effects in the context of severe housing busts, which gives rise to the importance of the implementation of fiscal stimulus packages. In addition, our results suggest that when governments run a budget deficit, they place an upward pressure on real interest rates, which ?crowds-out? private consumption and investment. In contrast, during bust periods, unexpected variation in the fiscal stance ? crowds-in? private spending, which reflects the ?direct? and ?indirect? effects of policy actions? impact arising from a downward movement in real interest rates and an upward revision in price level expectations.

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Bibliographic Info

Article provided by Presses de Sciences-Po in its journal Revue économique.

Volume (Year): 62 (2011)
Issue (Month): 6 ()
Pages: 1045-1066

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Handle: RePEc:cai:recosp:reco_626_1045

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  1. Jappelli, Tullio & Pistaferri, Luigi, 2007. "Do people respond to tax incentives? An analysis of the Italian reform of the deductibility of home mortgage interests," European Economic Review, Elsevier, vol. 51(2), pages 247-271, February.
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  5. Agnello, Luca & Schuknecht, Ludger, 2011. "Booms and busts in housing markets: Determinants and implications," Journal of Housing Economics, Elsevier, vol. 20(3), pages 171-190, September.
  6. Holtz-Eakin, Douglas & Newey, Whitney & Rosen, Harvey S, 1988. "Estimating Vector Autoregressions with Panel Data," Econometrica, Econometric Society, vol. 56(6), pages 1371-95, November.
  7. Bas van Aarle & Harry Garretsen & Florence Huart, 2003. "Transatlantic Monetary and Fiscal Policy Interaction," CESifo Working Paper Series 1042, CESifo Group Munich.
  8. Agnello, Luca & Nerlich, Carolin, 2012. "On the severity of economic downturns: Lessons from cross-country evidence," Economics Letters, Elsevier, vol. 117(1), pages 149-155.
  9. Love, Inessa & Zicchino, Lea, 2006. "Financial development and dynamic investment behavior: Evidence from panel VAR," The Quarterly Review of Economics and Finance, Elsevier, vol. 46(2), pages 190-210, May.
  10. Ardagna, Silvia, 2009. "Financial markets' behavior around episodes of large changes in the fiscal stance," European Economic Review, Elsevier, vol. 53(1), pages 37-55, January.
  11. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
  12. Bradley, John & Whelan, Karl, 1997. "The Irish expansionary fiscal contraction: A tale from one small European economy," Economic Modelling, Elsevier, vol. 14(2), pages 175-201, April.
  13. Darrat, Ali F., 1990. "Stock Returns, Money, and Fiscal Deficits," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(03), pages 387-398, September.
  14. Sousa, Ricardo M., 2010. "Housing wealth, financial wealth, money demand and policy rule: Evidence from the euro area," The North American Journal of Economics and Finance, Elsevier, vol. 21(1), pages 88-105, March.
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Cited by:
  1. Luca Agnello & Vitor Castro & Ricardo M. Sousa, 2011. "How Does Fiscal Policy React to Wealth Composition and Asset Prices?," GEMF Working Papers 2011-18, GEMF - Faculdade de Economia, Universidade de Coimbra.
  2. Vítor Castro & Megumi Kubota, 2013. "Duration dependence and change-points in the likelihood of credit booms ending," NIPE Working Papers 09/2013, NIPE - Universidade do Minho.
  3. Agnello, Luca & Schuknecht, Ludger, 2011. "Booms and busts in housing markets: Determinants and implications," Journal of Housing Economics, Elsevier, vol. 20(3), pages 171-190, September.
  4. Luca Agnello & Vítor Castro & Ricardo M. Sousa, 2012. "Are there change-points in the likelihood of a fiscal consolidation ending?," NIPE Working Papers 18/2012, NIPE - Universidade do Minho.
  5. Agnello, Luca & Furceri, Davide & Sousa, Ricardo M., 2013. "How best to measure discretionary fiscal policy? Assessing its impact on private spending," Economic Modelling, Elsevier, vol. 34(C), pages 15-24.
  6. Agnello, Luca & Dufrénot, Gilles & Sousa, Ricardo M., 2013. "Using time-varying transition probabilities in Markov switching processes to adjust US fiscal policy for asset prices," Economic Modelling, Elsevier, vol. 34(C), pages 25-36.
  7. Fredj Jawadi & Ricardo M. Sousa, 2012. "Structural Breaks and Nonlinearity in US and UK Public Debt," NIPE Working Papers 25/2012, NIPE - Universidade do Minho.
  8. Athanasios O. Tagkalakis, 2013. "The output effects of systematic and non-systematic fiscal policy changes in Greece," Working Papers 167, Bank of Greece.
  9. Goodness C. Aye & Rangan Gupta & Mampho P. Modise, 2012. "Do Stock Prices Impact Consumption and Interest Rate in South Africa? Evidence from a Time-Varying Vector Autoregressive Model," Working Papers 201224, University of Pretoria, Department of Economics.
  10. Gnegne, Yacouba & Jawadi, Fredj, 2013. "Boundedness and nonlinearities in public debt dynamics: A TAR assessment," Economic Modelling, Elsevier, vol. 34(C), pages 154-160.

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