All modern governments strive for total control of their economic and monetary policies; unfortunately, global financial markets have taken that control away from many governments.
Government actions like subsidies and tariffs, regulations, taxes, and bailouts have a dramatic effect on stocks and entire industries. In this article we’ll examine these effects using financial modeling and valuation.
Subsidies and Tariffs
Governments often subsidize certain industries in an attempt to protect domestic companies and jobs. They do this by giving these industries preferential treatment in terms of financing or grants that enable them to access capital they would not have had access to otherwise; this in turn diverts resources away from more globally competitive sectors that do not receive similar support.
Tariffs are levied upon imported goods to make them more expensive – this may include both foreign products or domestic ones sold abroad such as large flat-screen TVs.
Tariffs may also be used to counteract specific trade practices, like “dumping”, where foreign producers sell goods at prices lower than would exist in a free market; these tariffs are known as antidumping tariffs. Subsidies and tariffs tend to interfere with free market operations by distorting market processes, creating market distortions, or decreasing efficiencies – and these practices should generally be avoided at all costs by businesses.
Regulations are an integral component of a healthy economy, yet they carry hidden costs that may not appear on government budgets. These costs fall on businesses and individuals alike and can force companies to postpone investments or product developments due to delays. Furthermore, certain regulatory policies do not benefit financial markets at all – for instance environmental regulations may increase production and operational costs as companies must purchase costly equipment to comply with new rules.
Governments are frequently called upon to strike a delicate balance between serving the interests of both their constituents and global market forces. When making these choices, governments must decide between stimulating the economy with spending and tax cuts or mitigating risks with reduced expenses and foreign borrowing – and it is crucially important that tradeoffs are carefully evaluated or else governments risk unintended economic repercussions that redistribute wealth or decrease living standards – this study highlights this need for serious discussion surrounding government policies.
Governments collect taxes and fees from households and businesses in order to finance public goods and services such as education, health care, roads and telecommunications. Taxation serves as a key instrument in maintaining economic stability while encouraging private-sector investments that drive sustainable economic development.
In this issue brief, we explore how a financial transaction tax (FTT), an excise tax imposed upon trading of securities like stocks, bonds, and derivatives, could reduce inequality, market inefficiency, and raise hundreds of billions. Furthermore, we assess its potential effect on liquidity by studying reactions to its introduction in France and Italy.
We found that government policies taken against the COVID-19 pandemic–such as school closures, resumption of flights, virus testing and quarantine–have had a detrimental impact on stock returns while public information campaigns had an indirect and substantial positive effect on liquidity. This proves that while critics claim FTTs would damage markets by restricting liquidity levels, evidence contradicts such claims.
Bailouts for financially distressed companies promote risky behavior by incentivizing firms to borrow excessively, knowing they will be bailed out in case of financial crise. Furthermore, this action prevents liquidated assets from being put to use by better managed competitors and sustainable business models; ultimately leading to economic disruption as a whole.
Bianchi’s model shows that an optimal bailout policy includes an appropriate debt tax that firms pay to discourage overborrowing. While systemic policies with no debt tax work well from both a macro and welfare perspective, moral hazard remains present without this measure in place. An idiosyncratic bailout policy often has devastating economic repercussions from excessive borrowing as well as encouraging moral hazard; its implementation can even worsen economic damage caused by overborrowing and increase moral hazard risk further.
Research on bail-ins, in which governments acquire equity stakes in financial institutions in return for bailout funds, remains relatively new and has yet to reach definitive conclusions about their impact on competition, credit supply, bank risk and real economy performance. Early evidence does indicate that bail-ins increase market discipline while decreasing both bank risk and systemic risk and the likelihood and duration of financial crises.