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Using time-varying transition probabilities in Markov switching processes to adjust US fiscal policy for asset prices

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  • Agnello, Luca
  • Dufrénot, Gilles
  • Sousa, Ricardo M.

Abstract

This paper tests for nonlinear effects of asset prices on the US fiscal policy. By modeling government spending and taxes as time-varying transition probability Markovian processes (TVPMS), we find that taxes significantly adjust in a nonlinear fashion to asset prices. In particular, taxes respond to housing and (to a smaller extent) to stock price changes during normal times. However, at periods characterized by high financial volatility, government taxation only counteracts stock market developments (and not the dynamics of the housing sector). As for government spending, it is neutral vis-a-vis the asset market cycles. We conclude that, correcting the fiscal balance and, notably, the revenue side for time-varying effects of asset prices provides a more accurate assessment of the fiscal stance and its sustainability.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:ecmode:v:34:y:2013:i:c:p:25-36
    DOI: 10.1016/j.econmod.2012.11.054
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    Cited by:

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    More about this item

    Keywords

    Fiscal policy; Asset prices; Time-varying transition probability Markov process;
    All these keywords.

    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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