Governments generally say they don't like to take an active role in the securities market (except for regulating it); however, there are methods and policies by which the government's actions may have an indirect influence on the market.

Fiscal policies that affect the taxation of capital gains, dividends and interest gains may eventually have an effect on market activity. For example, favorable policies such as tax cuts could persuade investors to become more active in buying and selling securities, while unfavorable policies might cause individuals to move to fixed-income securities or alternative investments (such as real estate or other appreciable assets).

Furthermore, through monetary policies, governments can indirectly involve themselves in the market by adjusting interest rates and taking part in open-market operations. In theory, cutting rates will discourage investors and companies from putting (or parking) their money into fixed-income investments - the lower rates instead may encourage borrowing for investment purposes.

The market is also affected by the bills and laws passed by the various levels of government. This can occur for those laws directed specifically at the securities market or those that have an indirect affect. For example, on the direct side, the government inacted the Sarbanes-Oxley Act in 2002, which established stricter securities regulations on publically traded companies. This has led to stricter accounting and auditing guidelines, increased corporate responsibility and increased disclosure, with the intention of providing more clarity for investors.

On the indirect side, if the government reduces spending in areas such as health care or defense, companies in these sectors will likely sell off as they rely in part on government funds.

To keep reading about this subject, see What Is Fiscal Policy?

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  4. How do fiscal and monetary policies affect aggregate demand?

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