Three essays on the impact of monetary and fiscal policy on financial markets
This investigation examines the effects of monetary and fiscal policy on financial markets. Essays one and two examine the stock market. Specifically, the proportions of the movements of the stock price index which can be attributed to changes in monetary and fiscal policy are examined.^ Essay one presents a model which relates movements in the stock market to movements in aggregate consumption. A regression model is used to relate changes in consumption to movements in government spending, the tax rate, the real money supply and real GNP. Agents are assumed to have perfect foresight with respect to the government budget deficit. Monetary and fiscal policy are shown to affect the movements in the stock price through their effect on consumption. A simulation technique is described which decomposes the shocks to the real stock price index into shocks to government spending, the tax rate, real GNP and the money supply.^ Essay two uses a vector autoregression to examine the importance of changes in monetary and fiscal policy to movements in the stock price index. The theoretical model used to relate monetary and fiscal policy to the stock market is essentially the same as in essay one, however, the perfect foresight assumption is dropped.^ Essay three presents a theoretical model which demonstrates the impact of monetary and fiscal policy on the term structure of interest rates. A representative agent optimal control model is used to derive the demand for money, bonds and capital. The fiscal authority is assumed to set a constant budget deficit. The monetary authority sets the steady state interest rate by conducting open market operations. The interaction of the agent's optimal asset demands and the government's policies determines the instantaneous interest rate process and the dynamics of the optimal portfolio of wealth. Monetary and fiscal policy affect the term structure through their effect on the instantaneous interest rate process and the covariance of this process with the optimal portfolio of wealth. ^
Major Professors: John A. Carlson, Purdue University, Sheng Cheng Hu, Purdue University.