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Fiscal policy shocks and stock prices in the United States

Working papers
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Download PDF: Working Paper 48


This paper shows that fiscal policies seeking to stimulate long-run economic activity lead to higher stock prices

Authors: Haroon Mumtaz (Queen Mary University) and Konstantinos Theodoridis (ESM)



This paper uses structural vector autoregressive models (SVARs) to show that the response of US stock prices to fiscal shocks changed in 1980. Over the period 1955-1979, an expansionary spending or revenue shock was associated with higher stock prices. After 1980, the response of stock prices to the same shock became negative. Using a dynamic stochastic general equilibrium (DSGE) model with a detailed fiscal sector, we show the pre-1980 results may be driven by an expansion in supply after the fiscal shock. In contrast, endogenous growth mechanisms appear to be weaker in the post-1980 period with positive fiscal shocks pushing down consumption, total factor productivity (TFP), and causing inflation and the real interest rate to rise.

Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.

Keywords: Fiscal policy shocks, Stock prices, VAR, FAVAR, DSGE

JEL codes: E24, E32, J64, C11

Source: European Stability Mechanism | Working Paper Series | Volume 2021 | No 48 | May 2021 | 33 Pages

Copyright © European Stability Mechanism, 2021 | All rights reserved. Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the European Stability Mechanism.