【Topic】Active Monetary or Fiscal Policy and Stock-Bond Correlation

We propose a New Keynesian model with monetary-fiscal policy regime switch to explain the time-varying correlation between returns on the market portfolio and nominal Treasury bonds found in the data. In the active monetary and passive fiscal policy (AMPF) regime, neutral technology (NT) and marginal efficiency of investment (MEI) shocks are the most important drivers of economic fluctuations and the stockbond correlation. In the passive monetary and active fiscal policy (PMAF) regime, the effect of the NT shock is depressed due to the weak reaction of short-term nominal interest rate to inflation, while the effect of the MEI shock remains strong. Because the NT shock leads to positive stock-bond correlation in the AMPF regime, while the MEI shock leads to negative correlation in the PMAF regime, our model provides a coherent explanation for the negative correlation between the market portfolio and long-term nominal Treasury bond returns during 1950s and 2000s when the fiscal policies are active, and for the positive correlation during 1980-2000 when monetary policies are active.

[Speaker] Li Xuenan, Cheung Kong Graduate School of Business

[Time] 10:00 am, November 23

[Location] Room 509, Mingde Main Building

Xuenan Li is an associate professor of finance at Cheung Kong Graduate School of Business, PhD in Finance at the University of Rochester, PhD in physics at the University of Massachusetts. 2007-2012 Assistant Professor of Finance at the Ross School of Business, University of Michigan. Joined Cheung Kong Graduate School of Business in 2012, taught asset securitization and behavioral finance, and was mainly engaged in academic research on asset pricing, monetary policy, and corporate governance. Her papers have been published in top journals, Review of Financial Studies, Journal of Monetary Economics, and Management Sciences.