The European Central Bank has published a working paper that models and tests how fiscal stimulus announcements can transmit information about policymakers’ assessment of economic conditions, potentially weakening the stabilising impact of fiscal policy. The paper argues that when a fiscal package is larger than markets expected, it may be interpreted as a signal of greater government pessimism about the recession, with these “signaling effects” becoming more pronounced when uncertainty is high. Using a stylised imperfect-information framework and a newly constructed Japan dataset linking daily Nikkei 225 movements to narrative fiscal news on 34 supplementary packages (1992–2022), the authors find that stock prices typically react positively to fiscal news absent signaling, including in large spending announcements treated as exogenous to the business cycle. By contrast, for supplementary packages intended for stabilisation, elevated uncertainty (proxied by Nikkei 225 volatility) combined with larger-than-expected stimulus is associated with negative stock-price reactions, including an estimated 2.6% fall when uncertainty is one standard deviation above average and expected government spending is revised up by one percentage point around size announcements. A threshold vector autoregression that distinguishes fiscal news by the co-movement of stock prices and spending-expectation revisions finds that under high uncertainty, output rises for news with minor signaling effects but falls for news with significant signaling effects, with a 10 basis-point upward revision in expected annual government expenditure growth linked to a 50 basis-point decline in real GDP growth at the peak; under low uncertainty, output responses are not statistically significant.
European Central Bank 2025-09-15
European Central Bank working paper finds surprise fiscal stimulus announcements can depress stocks and reduce output under high uncertainty
The European Central Bank's working paper examines how fiscal stimulus announcements signal policymakers' economic assessments, potentially undermining fiscal policy's stabilizing effects. Using a Japan dataset, the study finds larger-than-expected fiscal packages during high uncertainty can lead to negative stock-price reactions and reduced GDP growth. The research highlights the nuanced impact of signaling effects on economic outcomes under varying uncertainty levels.