Fiscal policy and stock market efficiency: Evidence for the United States

This paper examines the extent to which fiscal policy actions affect the stock market's behavior for the US during 1968-2005. The findings are consistent with the hypothesis that past budget deficits negatively affect current stock returns thus suggesting that the market is inefficient with respect to information about future fiscal policy actions. One interpretation of this 'disturbing' result is that market participants do not place much faith on news about the budget deficits as they do not believe that deficits could adversely impact the stock market. Instead, what the market considers most important is news about monetary policy. (C) 2007 The Board of Trustees of the University of Illinois. Published by Elsevier B.V. All rights reserved.