Question

As a portfolio manager, how would you allocate assets and and select investment products within your portfolio when the government inplement contractionary fiscal policies?

Please explain in 500 words.

Answer 1

Answer-

Government is responsible for fiscal policy in the economy and it uses the power to maneuver the economy. Expansionary policy is used to stimulate the economy when it is in recession. On the other hand, contractionary policy is used when there chances of overheating of the economy.

Contractionary policy involves curbing aggregate demand in the economy through raising taxes or reducing government expenditure or using both the tools. This policy reduces disposable income available for the consumption and also decreases corporate profit. However, this could raise interest rate in the economy and it gives an opportunity to invest in interest rate sensitive assets.

Monetary policy is a macroeconomics concept and it is generally used to control the money supply and interest rate of an economy. It is also ised to control or set inflation, consumption , Liquidity etc. while on the other hand the fiscal policy is the measure which is used to alter the government spending and tax rates for the growth of the expnomy. It is considered to be a side policy or sister policy of the mometary policy as both of them in some way are used to control the momey supply.

If we look at the fiscalmpolicy then we will see that it affects the business as it affcts the production of goods and services by either increasing it by making favourable situation or curbing it. Fiscal policy changes can also help in investment decisions and jobs creation. Fiscal policy by increasing the tax rate and interest rate can significantly influence the business entities of the United states of America.

When suchvrates as set high then it raisies the cost of production for the firms and thus firms find it difficult to but raw materials from their home country and eventually start importing it. And if suppose the government plans to increase the wage rate also then the cost of production will further increase the xost of the production which will force firms to cut the medical or medicare which they are prociding to the employees to cut the rising cost of production. If such conditions are made true then the firm who is looking for some loan to invest in a machinery or for other investment purposes will not be able to do so because of the high intetest rates.

This situation will not promote any economic growth as the investors will nownlook for foreign source of raising funds. In order for a firm to be competitive it must lower it’s cost of goods and services so that it can outperform it’s competitors. The federal bank of USA in consultation with the IS government sets the interest rates and thus the money supply is controlled by the federal bank of USA as per the interest rate set. These decisions can affect the business entities.

The government must set the monetary policy in the favour of the nation because if the borrowing cost is set low then more people will loan momey and this will increase the money supply and thus the indlation may also rise due yo which the prices of goods wil increase and the government will eventually set the interest rates high so that people will hesitate from borrowing money and the money supply will be controlled. Interest rates have a bearing on the foreign exchange rates also as when the interest rates are dropped the doreign investors will loan money from USA due to cheap loans available and vice versa. Thus in the situation of low interest rates the money flow from foreign source increases.