Fiscal policy and stock markets at the effective lower bound

Abstract

We study the impact of fiscal policy at the effective lower bound (ELB) in the stocks markets of the Euro Area, by specifically looking at a government spending shock. To uncover the impact of this shock, we estimate a factor-augmented interacted panel vector-autoregressive (FAIPVAR) model. We find statistically different impacts of the government spending shock across the ELB and non-ELB periods, with relatively stronger positive impact on stock returns under the former. Conversely, the differences are not statistically significant for the United States using a time series data-based FAIVAR. Our findings have important implications from the perspectives of both policymaking and investors.