Abstract
How fiscal policy impacts equity and bond returns is an open question. Unlike previous studies, we address this issue in a way that decomposes current returns into news about cash flows and news about discount rates. Moreover, we use narrative methods to identify plausibly exogenous shocks to fiscal policy. Our main findings suggest that tax increases lead to lower cash flow news and lower discount rates. However, the discount rate news dominates so that higher taxes are associated with higher equity returns. We confirm these results with simulations from a standard New Keynesian DSGE model.
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