The Signaling Effects of Fiscal Announcements

Announcing a large fiscal stimulus may signal the government’s pessimism about the
severity of a recession to the private sector, impairing the stabilizing effects of the
policy. Using a theoretical model, we show that these signaling effects occur when the
stimulus exceeds expectations and are more noticeable during periods of high economic
uncertainty. Analysis of a new dataset of daily stock prices and fiscal news in Japan
supports these predictions. We introduce a method to identify fiscal news with different
degrees of signaling effects and find that such effects weaken or, in extreme cases, even
completely undermine the stabilizing impact of fiscal policy.