We analyze the effect of taxes and government spending on quarterly market returns of stocks, government bonds, and corporate bonds. In US data from 1960 to 2000, a one standard deviation increase in the share of tax receipts in GDP has a statistically and economically significant effect on returns, lowering annualized expected returns by 4% and 9% at quarterly and yearly horizons, respectively. Istrestingly, the impact of taxes is quantitatively similar for stock and bond returns. These results can partly be explained by the high persistence of the tax series so that increases today imply permanently higher tax levels in the future. An increase in government spending has a positive impact on expected returns, but the effect is statistically significant only for bonds, at short horizons. Our findings represent a novel test of Ricardian Equivalence, using market returns. Fiscal Policy shocks account for 3-4% of the variation in unexpected excess stock returns and 8-10% of the variation in unexpected excess bond returns. When fiscal and monetary policy changes are jointly identified, our results remain qualitatively unchanged and the quantitative results are only reinforced. More importantly, we find that fiscal policy is at least as important a source of return variability as is the policy of the Federal Reserve. The findings are surprisingly robust to various system specifications, such as cointegration assumptions and variable choice. Our results strongly suggest that fiscal policy shocks should be given more serious consideration in asset pricing.
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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number
wp413.
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Find related papers by JEL classification: G12 - Financial Economics - - General Financial Markets - - - Asset Pricing G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Elmendorf, Douglas W. & Gregory Mankiw, N., 1999.
"Government debt,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 25, pages 1615-1669
Elsevier.
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Douglas W. Elmendorf & N. Gregory Mankiw, 1998.
"Government Debt,"
NBER Working Papers
6470, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Chari, V.V. & Kehoe, Patrick J., 1999.
"Optimal fiscal and monetary policy,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745
Elsevier.
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