Can fiscal policy stimulus boost economic recovery?

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.