A:

Expansionary economic policy leads to increases in the stock market because it generates increased economic activity. Policymakers can implement expansionary policy through monetary and fiscal channels. Typically, it is employed when the economy is slipping into a recession and inflationary pressures are dormant.

Fiscally, expansionary policy will lead to increases in aggregate demand and employment. This translates into more spending and higher levels of consumer confidence. Stocks rise, as these interventions lead to increased sales and earnings for corporations.

Fiscal policy is quite effective in stimulating economic activity and consumer spending. It is simple in its transmission mechanism. The government borrows money or dips into its surplus and gives it back to consumers in the form of a tax cut, or it spends the money on stimulus projects.

On the monetary side, the transmission mechanism is more circuitous. Expansionary monetary policy works by improving financial conditions rather than demand. Lowering the cost of money will increase the money supply, which pushes down interest rates and borrowing costs.

This is particularly beneficial for the large multinational corporations, which make up the bulk of the major indexes of the stock market, such as the S&P 500 and Dow Jones Industrial Average. Due to their size and massive balance sheets, they carry huge amounts of debt.

Decreases in interest rate payments flow straight to the bottom line, pumping up profits. Low rates prompt companies to buy back shares or issue dividends, which is also bullish for stock prices. In general, asset prices do well in an environment as the risk-free rate of return rises, specifically income-generating assets such as dividend-paying stocks. This is one of the goals of policymakers to push investors to take on more risk.

Consumers get relief as well with expansionary monetary policy due to lower interest rate payments, improving the consumer balance sheet in the process. Additionally, marginal demand for major purchases such as automobiles or homes also rises as financing costs decrease. This is bullish for companies in these sectors. Dividend-paying sectors such as real estate investment trusts, utilities and consumer staple companies also improve with monetary stimulus.

In terms of what is better for stocks – expansionary fiscal policy or expansionary monetary policy – the answer is clear. Expansionary monetary policy is better. Fiscal policy leads to wage inflation, which decreases corporate margins. This decrease in margins offsets some of the gains in revenue. While wage inflation is good for the real economy, it is not good for corporate earnings.

With monetary policy due to the transmission mechanism, wage inflation is not a certainty. A recent example of the effect of monetary policy on stocks has been after the Great Recession, when the Federal Reserve cut interest rates to zero and started quantitative easing. Eventually, the central bank took on $3.7 trillion worth of securities on its balance sheet. Over this time period, wage inflation remained low, and the S&P 500 more than tripled climbing from its low of 666 in March 2009 to 2,100 in March 2015.

RELATED FAQS
  1. What are some examples of expansionary fiscal policy?

    Learn about expansionary fiscal policy – tax cuts and government spending – that are used by governments to boost spending ... Read Answer >>
  2. How long should an expansionary economic policy be implemented?

    Finding the optimal time period to end expansionary economic policy is an urgent issue; the key is found with capacity utilization. Read Answer >>
  3. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
  4. How does fiscal policy impact the budget deficit?

    Find out how the different uses of fiscal policy impact a government's budget deficit, and the difference between contractionary ... Read Answer >>
  5. How Do Fiscal and Monetary Policies Affect Aggregate Demand?

    Learn about the impact fiscal and monetary policy have on aggregate demand, and discover how the government influences economic ... Read Answer >>
  6. What are some different kinds of expansionary policy?

    Learn the most popular types of expansionary policy used by the federal government and the Federal Reserve to increase the ... Read Answer >>
Related Articles
  1. Insights

    Fiscal Vs. Monetary Policy Pros & Cons

    When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two primary courses of action: monetary policy and fiscal policy.
  2. Insights

    A Look at Fiscal and Monetary Policy

    There's a debate over which policy is better for the economy. Find out which side of the fence you're on.
  3. Trading

    A Look At Fiscal And Monetary Policy

    Fiscal and monetary policies provide our government and the Federal Reserve with two powerful tools to regulate the economy.
  4. Insights

    The Top 6 Ways Governments Fight Deflation

    Here are six monetary and fiscal policy tools that governments use to fight deflation.
  5. Insights

    Not Crazy: Unconventional Monetary Policy

    Unconventional monetary policy, such as quantitative easing, can be used to jump-start economic growth and spur demand.
  6. Investing

    Central Bankers' Role in Keynesian Economics

    Learn about the role of monetary policy in Keynesian economics, and examine how central banks impacted aggregate demand in the aftermath of the 2008 crisis.
  7. Insights

    Is U.S. Inflation on the Horizon?

    Inflation, or the general price level of all goods and services in an economy, has remained subdued in the years following the Great Recession. Given recent developments, is the U.S. on the verge ...
  8. Financial Advisor

    Why Positive Economic Data Pushes the Market Down

    Unemployment comes in higher than analysts’ expectations, and the market rallies 1% instead of dropping. GDP growth exceeds expectations slightly, and markets drop. Why could this be happening?
  9. Investing

    What Causes Inflation in the United States

    Inflation is the main catalyst behind U.S monetary policy. But what causes this phenomenon of sustained rising prices? Read on to find out.
  10. Insights

    Bank of Japan Keeps Policy Steady, Upgrades Outlook

    In its last monetary policy decision of the year and the first one since the U.S. elections, The Bank of Japan announced it will keep its monetary policy unchanged.
RELATED TERMS
  1. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  2. Easy Money

    In the most literal sense, money that is easily acquired. Academically ...
  3. Contractionary Policy

    A type of policy that is used as a macroeconomic tool by the ...
  4. Accommodative Monetary Policy

    When a central bank (such as the Federal Reserve) attempts to ...
  5. Stimulus Package

    A stimulus package is a package of economic measures put together ...
  6. Non-standard Monetary Policy

    Non-standard monetary policy, or unconventional monetary policy, ...
Hot Definitions
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  2. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  3. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  4. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  5. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  6. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
Trading Center