5.1 Introduction

Introduction

Once a year, typically in February, the federal minister of finance announces the government’s budgetary requirements. This announcement, often referred to as the federal budget, serves as an annual fiscal policy scorecard detailing government spending and taxation measures. Not far from Parliament Hill, the Bank of Canada uses monetary policy to maintain economic equilibrium. Though the government and the Bank of Canada operate largely independently, they share the common objective of fostering long-term, sustained economic growth.

What is Fiscal Policy?

Fiscal policy involves the use of government revenue collection (taxation) and expenditure (spending) to influence the economy. Examples of fiscal policy measures include:

1. Tax Reductions/Increases: Changes in personal or corporate tax rates.
2. Government Spending: Public investments in infrastructure, healthcare, education, etc.
3. Budget Deficit/Surplus: Managing the balance between government income and expenditure.

What is Monetary Policy?

Monetary policy involves controlling the supply of money and interest rates by the central bank (the Bank of Canada) to influence economic activity. Measures taken by the Bank of Canada include:

1. Interest Rates: Adjusting the benchmark interest rates (e.g., overnight rate).
2. Open Market Operations: Buying or selling government bonds to influence money supply.
3. Reserve Requirements: Mandating the amount of funds that banks must hold in reserve.

Importance in Investment Decisions

Understanding fiscal and monetary policy is critical for making informed investment decisions. Economic policies can influence various asset classes, interest rates, and market dynamics. For instance:

• Expansion Phase: If the economy is expanding, potential increases in interest rates by the Bank of Canada might encourage investment in fixed-income securities with anticipated higher yields.
• Recession Phase: If the economy is in recession, government fiscal stimulus as a countermeasure might guide investors to look into sectors benefiting from increased public spending.

Frequently Asked Questions (FAQs)

Q1: What is the key difference between fiscal and monetary policy?

A1: Fiscal policy pertains to government spending and tax policies used to influence the economy, while monetary policy involves managing the money supply and interest rates, primarily conducted by the central bank.

Q2: How does the federal budget affect investments?

A2: The federal budget impacts economic growth, taxation, and government spending, directly affecting business profitability, consumer behavior, and investment returns.

Q3: How can interest rate changes affect my portfolio?

A3: Changes in interest rates can influence the valuation of bonds, equities, and other asset classes, affecting the yield and risk profile of your investment portfolio.

Key Takeaways

• Fiscal and Monetary Policy Overview: Understand the distinct roles of fiscal and monetary policy in the economy.
• Investment Implications: Recognize how economic policy decisions influence market conditions and investor strategies.
• Practical Application: Use knowledge of fiscal and monetary actions to evaluate economic indicators and make well-informed investment choices.

Glossary

• Fiscal Policy: Government policies related to taxation and spending to influence economic conditions.
• Monetary Policy: Central bank actions aimed at managing the money supply and interest rates.
• Interest Rates: The amount charged by lenders to borrowers, influenced by central bank policies.
• Expansion Phase: A period of economic growth in the business cycle.
• Recession Phase: A period of economic decline marked by reduced spending and rising unemployment.

Visualization: Business Cycle Phases

    graph LR
	    A[Expansion]
	    B[Peak]
	    C[Contraction]
	    D[Trough]
	
	    A --> B
	    B --> C
	    C --> D
	    D --> A

Understanding how fiscal and monetary policy decisions impact each phase can guide in choosing investment strategies that align with economic conditions.