Government decisions and macroeconomic stability: Fiscal policies and financial market fluctuations

Abstract

Since the 2008 Financial crisis, macroeconomic and financial markets' stabilisation policies relied mainly on monetary actions, reducing the ECB's margin of manoeuvre and calling for a major role for fiscal authorities. We investigate the impact of government decisions on financial markets for 11 Eurozone economies (from 1995 to 2021), in the very short run, using an event study, finding a positive (negative) reaction to fiscal expansion (consolidation) announcements and in the short/medium-run, with a Bayesian TVP-FAVAR, identifying cross-country heterogeneities; stronger (weaker) public finances show a direct (indirect) relation between fiscal policies and stock prices and an indirect (direct) one with 10-year bond yield.