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

Author

Listed:
  • Luca Agnello

    (University of Palermo, Department of Economics, Business and Finance)

  • Gilles Dufrénot

    (University of Aix-Marseille II, Research Center of Economic Development and International Finance)

  • Ricardo M. Sousa

    (Universidade do Minho - NIPE)

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.

Suggested Citation

  • Luca Agnello & Gilles Dufrénot & Ricardo M. Sousa, 2012. "Adjusting the U.S. Fiscal Policy for Asset Prices: Evidence from a TVP-MS Framework," NIPE Working Papers 20/2012, NIPE - Universidade do Minho.
    • Handle: RePEc:nip:nipewp:20/2012
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    Keywords

    Fiscal policy; asset prices; time-varying transition probability Markov process.;
    All these keywords.

    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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