U.S. Asset Returns and Fiscal Policy: New Empirical Investigation

Document Type

Article

Publication Title

Quarterly Journal of Business and Economics

ISSN

0747-5535

Volume

43

Issue

3&4

First Page

31

Last Page

47

Publication Date

Summer 9-1-2004

Abstract

The persistent government budget deficit that has plagued both the United States and other countries since the 1970s invariably has attracted attention from academicians and politicians. Although the United States enjoyed a brief period of federal budget surplus from 1998 to 2001, it is once again experiencing a ballooning budget deficit, partly due to a recession in 2001, to extended bearish stock markets fueled by the dotcom bust in 2000, and to a significant boost in government spending to fight the war against terrorism. This study investigates whether the U. S. stock and corporate bond markets are informationally efficient with respect to fiscal policy (proxied by government budget deficit). The Granger causality test procedure is utilized in the context of a vector autoregression (VAR) model to investigate a dynamic relationship between excess U. S. asset returns and fiscal policy. This study finds that both stock (small-capitalization as well as large-capitalization) and bond excess returns fully captured information on fiscal and monetary policies in the United States during the period 1969-1998, a period marked by persistent budget deficit.

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