Public Policy – How Governments Can Influence Markets

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For better or worse, governments and the decisions they make will always have an impact on the economy and often influence markets. Taxes, monetary policy, industrial subsidies, and business regulation all play key roles in how the economy functions, and can even determine the success of individual businesses, or, in some cases, even entire industries. No government, even one replete with experienced economists with masters in public policy, can effectively control the economy of an entire country.

The level of government involvement in the market varies by country; some governments exercise a firm hand, while others are more laissez-faire. With that said, it would be a grave mistake to underestimate the level of influence a government can exercise over the market it governs – or, in some cases, those of other countries, or even the global economy.

Fiscal Policy

Tax is a hot topic that comes up in election after election. Businesses would always like to pay less tax, whether it be on the payroll, income, or dividend distributions. The existing body of research supports this sentiment: studies by the OECD and IMF confirm that stricter fiscal policy translates to lower productivity.

This is especially true for industries that are dependent on investment and entrepreneurial activity to stimulate growth. In this sense, governments are an inherent burden on the markets they govern.


Governments need to regulate markets, too – and with good reason! In the past, when governments haven’t intervened on behalf of their people in market affairs, some really awful things have happened. When left unregulated, industries tend to pollute more, pay less, treat workers poorly, and distribute substandard or even dangerous products.

Industrial regulations are a necessary part of life that keep workers and consumers safe from the most depraved excesses of greed and negligence. Unfortunately, they come at a cost: regulations tend to cater to the lowest common denominator, and sometimes broad regulations can hamper business productivity by inadvertently limiting the flexibility of businesses to respond to market signals.

Sometimes this is done intentionally. Regulations are a tool that governments usually use to protect their people in some direct sense, but they can also be used politically. Sanctions, tariffs, and even embargoes can dramatically impact the economy of the country targeted by them. These are often viewed as financial “weapons” that a country can use to send a message to another country that impinges upon its interests or engages in threatening behavior.

A prime example is North Korea, a country that, as a result of ongoing aggressive rhetoric, has been all but completely isolated from the global economy, and has suffered greatly as a result. A less extreme, but perhaps even more important example would be American sanctions on the Chinese semiconductor industry.


Governments don’t just hurt markets, though – they can also help and often do. Even the wealthiest hedge funds and venture capitalists can’t hold a candle to the amount of money that even a small government has the ability to inject into the market. Industrial subsidies can go a long way to improving specific industries, especially those that need big investments to get started or cross a new hurdle in innovation.

Tax incentives can help, too – tax incentives on certain types of investments might make investors more attracted to industries that a government deems ripe for expansion. Studies confirm that tax incentives and stimulus spending can have positive impacts on innovation and productivity, especially in industries that rely heavily on R&D spending to sustain growth.

Monetary Policy

So, we should just lower taxes and give out lots of industrial subsidies and incentives, and everything will be great, right? It sounds like a great idea on paper, but the big budgets accessible to governments come with big bills to pay, and they need tax revenue to pay for the services that we all depend on every day, like roads, defense, and expensive dinner parties for campaign donors and the press.

Unfortunately, the government can’t just print endless money…well, technically, it can, but it wouldn’t be a good idea. This is where monetary policy comes in. Currency management is too complicated to explain briefly; even senior economists and experienced finance professionals would be hard-pressed to understand the complexities of the currency exchange market.

Monetary Policy, Simplified

Perhaps the simplest way to understand monetary policy is to think in terms of basic economics: the greater the supply of a currency, the less value it has. That means when a government prints more money, the value of that currency decreases. And when that happens, all assets denominated in that currency are likely to decrease, and that includes every item on every balance sheet of every company on that country’s stock exchange!

The effect is, perhaps counterintuitively, less on currencies with lower public repute or those that are openly manipulated, like the Chinese RMB or the Russian ruble. This makes a bit more sense when we consider that the market value of such currencies likely already has substantial depreciation as a result of presumed manipulation and excessive money printing “baked in” to the market value.

The Role of Monetary Policy

Monetary policy isn’t just about printing and spending money. Governments control the interest rates set on loans made in their currencies by dictating the rates at which commercial banks can borrow from central banks.

Rates are often decreased to stimulate spending and lending by banks by increasing the supply of capital; this is basically like printing money but giving it to banks to loan instead of giving it directly to people or companies. Increasing interest rates, on the other hand, is normally done to prevent inflation caused by lower rates or the actual printing of money.

More advanced, aggressive forms of monetary policy, like quantitative easing, can be implemented during times of crisis. Quantitative easing involves central banks buying back targeted amounts of bonds from creditors to stimulate demand for their currency and encourage private bank lending at competitive rates without lowering central bank interest rates, presumably by increasing public confidence in the currency and thereby seeming to ensure better returns on any investment – a bit like a company trying to inspire confidence by buying back its own stock.

Monetary Policy & Government

Governments can also engage in more dishonest forms of monetary policy, like currency pegging or devaluation, both forms of currency manipulation designed to increase the competitiveness of a country’s exports in global markets by ensuring that they are priced lower relative to those of goods from competing countries, thereby driving demand for that country’s products and encouraging economic growth and foreign investment.

This is something the Chinese government is frequently accused of. In 2020, the US government engaged in some very novel and seemingly effective monetary policy by offering near-zero interest overnight loans to large banks, encouraging them to buy stocks in order to stop markets from crashing, thereby emboldening retail and institutional investors and stimulating real economic growth.

The tools available to governments – especially large ones – to influence markets are as varied as they are numerous. But, at the end of the day, the real task of any government is not to play financial games, but rather to help stimulate growth when necessary and reduce any negative impact it might inadvertently have on the economy it is granted stewardship over. We can only hope that we, as people, elect and support the right leaders and that they do their jobs well!

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