Does fiscal policy matter for stock-bond return correlation?

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Date: May 2022
Publisher: Elsevier B.V.
Document Type: Report
Length: 406 words

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Abstract :

Keywords Stock-bond return correlation; Consumption-inflation correlation; Fiscal regime; Technology shock; Investment shock Highlights * Stock-bond return and consumption-inflation correlations switched sign in 2001. * Monetary-fiscal policy interaction explains sign changes of these correlations. * Technology shocks drove the correlations in the monetary regime before 2001. * Investment shocks drove the correlations in the fiscal regime after 2001. Abstract Switching between monetary and fiscal regimes is incorporated in a general-equilibrium model to explain three stylized facts: (1) a positive correlation of stock and bond returns in 1971--2001 and a negative correlation after 2001, (2) a negative correlation of consumption and inflation in 1971--2001 and a positive correlation after 2001, and (3) the coexistence of a positive bond risk premium and a negative correlation of stock and bond returns. While the technology shock drives the positive stock-bond and negative consumption-inflation correlations in the monetary regime, the investment shock drives the negative stock-bond and positive consumption-inflation correlations in the fiscal regime. Author Affiliation: (a) Department of Finance, Cheung Kong Graduate School of Business, China (b) Federal Reserve Bank of Atlanta, United States (c) Department of Economics, Emory University, United States (d) National Bureau of Economic Research, United States (e) PBC School of Finance, Tsinghua University, China (f) SUSTech Business School, Southern University of Sciences and Technology, China * Corresponding author. Article History: Received 8 May 2021; Revised 2 March 2022; Accepted 2 March 2022 (footnote)[white star] We are grateful to the referee and Francesco Bianchi for critical comments that help improve the paper significantly. We thank Hui Chen, Eric Leeper, Yang Liu, Deborah Lucas, Pengfei Wang, and participants in seminars and conferences at Cheung Kong Graduate School of Business, Tsinghua University PBC School of Finance, MIT Sloan Business School, Boston Fed, ABFER Annual Conference, and CEBRA Annual Meeting for helpful comments. We also thank Dan Waggoner for his help in programming and Eric Leeper for providing us with the data. This research is supported in part by the National Science Foundation Grant SES 1558486 through the NBER (awarded to Tao Zha) and by the National Natural Science Foundation of China under Grant No. 72003102 (awarded to Ji Zhang). The views expressed here are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the National Bureau of Economic Research. Byline: Erica X.N. Li [xnli@ckgsb.edu.cn] (a), Tao Zha [zmail@tzha.net] (b,c,d), Ji Zhang [zhangji@pbcsf.tsinghua.edu.cn] (*,e), Hao Zhou [zhouh@pbcsf.tsinghua.edu.cn] (f,e)

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Gale Document Number: GALE|A703193413