Can Fiscal Policy Stimulus Boost Economic Recovery?

29 Pages Posted: 8 Apr 2011

See all articles by Luca Agnello

Luca Agnello

Banque de France

Ricardo M. Sousa

University of Minho; Economic Policies Research Unit (NIPE); London School of Economics & Political Science (LSE) - Financial Markets Group; London School of Economics

Date Written: April 2011

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.

Keywords: Fiscal policy, asset prices, panel VAR

JEL Classification: E62, H30

Suggested Citation

Agnello, Luca and Sousa, Ricardo Magalhaes, Can Fiscal Policy Stimulus Boost Economic Recovery? (April 2011). Banque de France Working Paper No. 325, Available at SSRN: https://ssrn.com/abstract=1803221 or http://dx.doi.org/10.2139/ssrn.1803221

Luca Agnello (Contact Author)

Banque de France ( email )

Paris
France

Ricardo Magalhaes Sousa

University of Minho ( email )

Campus Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

Economic Policies Research Unit (NIPE) ( email )

Campus de Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://econ.lse.ac.uk

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