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How does fiscal policy react to wealth composition and asset prices?

Agnello, Luca and Castro, Vítor and Sousa, Ricardo J. (2012) How does fiscal policy react to wealth composition and asset prices? Journal of Macroeconomics, 34 (3). pp. 874-890. ISSN 0164-0704

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Identification Number: 10.1016/j.jmacro.2012.04.001

Abstract

We assess the response of fiscal policy to developments in asset markets in the US. We estimate fiscal policy rules augmented with aggregate wealth, wealth composition (i.e. financial and housing wealth) and asset prices (i.e. stock and housing prices) using two nonlinear specifications that rely on a Smooth Transition Regression (STR) and a Markov-Switching (MS) model and show that they outperform the linear framework that is based on a fully simultaneous system approach. In particular, the smooth transition regression model shows that primary spending and fiscal balance are adjusted in a nonlinear fashion to both wealth and price effects, while the Markov-switching framework highlights the importance of tax cuts to offset the decline in wealth during periods of major financial distress. Overall, our results provide evidence of a countercyclical policy and a vigilant track of wealth developments by fiscal authorities.

Item Type: Article
Official URL: http://www.journals.elsevier.com/journal-of-macroe...
Additional Information: © 2012 Elsevier
Subjects: H Social Sciences > HG Finance
H Social Sciences > HJ Public Finance
Sets: Research centres and groups > Financial Markets Group (FMG)
Date Deposited: 06 Jun 2012 15:47
Last Modified: 17 Aug 2012 12:13
URI: http://eprints.lse.ac.uk/id/eprint/44223

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