Budget deficits and stock prices: International evidence

The purpose of this research is to provide empirical evidence regarding deficits and their effects on stock prices. We investigate whether changes in deficits cause changes in stock prices and if so, in what direction. We use Granger causality tests and impulse response analysis of vector autoregressive models to assess the relationship between budget deficits and stock prices in several industrialized nations. The evidence from impulse response analysis and Granger causality tests shows that only in the U.S. deficit reductions have an inverse effect on equity returns.