Adjusting the U.S. Fiscal Policy for Asset Prices: Evidence from a TVP-MS Framework

Luca Agnello (), Gilles Dufrénot () and Ricardo Sousa

No 20/2012, NIPE Working Papers from NIPE - Universidade do Minho

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 (TVTP) Markovian processes, 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 prices 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.

Keywords: Fiscal policy; asset prices; time-varying transition probability Markov process. (search for similar items in EconPapers)
JEL-codes: E37 E52 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (1)

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