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.
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