Working Paper: NBER ID: w27861
Authors: Erica XN Li; Tao Zha; Ji Zhang; Hao Zhou
Abstract: We explore an important role of monetary-fiscal policy interactions in explaining three stylized facts: (1) a positive correlation of stock and bond returns in 1971-2001 and a negative one after 2001, (2) a negative correlation of consumption and inflation in 1971-2001 and a positive one after 2001, and (3) the coexistence of a positive bond risk premium and a negative correlation of stock and bond returns. Our general equilibrium model shows that these correlation changes across two policy regimes are driven by a combination of technology and investment shocks, while positive risk premiums are driven by the technology shock only.\n
Keywords: Fiscal Policy; Monetary Policy; Stock-Bond Correlation; General Equilibrium
JEL Codes: E52; E62; G12; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| technology shocks (D89) | output (C67) |
| technology shocks (D89) | consumption (E21) |
| technology shocks (D89) | prices (P22) |
| output (C67) | positive stock-bond return correlation (G12) |
| nominal interest rate (E43) | positive stock-bond return correlation (G12) |
| investment shocks (E22) | efficiency of transforming investment into capital (E22) |
| investment shocks (E22) | short-run consumption (E21) |
| short-run consumption (E21) | negative stock-bond correlation (G12) |
| technology shocks (D89) | risk premiums for bonds (G12) |