The Impact of Fiscal and Monetary Policy Changes on Investors’ Investment Performance: Empirical Evidence from Investors in the Colombo Stock Exchange in Sri Lanka

Abstract

The effect of fiscal and monetary policy is transmitted in several ways by investor choice and the performance of investments. This study investigates how individual investors perceive government fiscal and monetary policy decisions and how they respond to such policy changes to make profitable investments. The data were gathered from a diversified group of 364 individual investors in the Colombo Stock Exchange (CSE) by administering a structured questionnaire focusing on their opinions of fiscal and monetary policy changes. Factor analysis was carried out to identify the meaningful fiscal and monetary policy actions that determine individual investment decisions and performance. The results of multiple regression analysis show that the government’s choice of tax instruments has a significant influence on stock returns and all taxes jointly depress investor investment performance. Government expenditure as a fiscal policy variable has a positive impact on investor returns, implying that a continual increase in government expenditure will result in the enhancement of firm profits and returns to investors by allowing stock prices to go up. Thus, market participants might assume that expansionary fiscal policy signals an increase in future returns. Further, a decline in interest rates and an increase in money circulation under monetary policy impacts positively on investors’ investment performance. As expected, an increase in money circulation in the economy will persuade investors to invest more in stocks as extra funds are available. These results have important implications for both investors and stock market analysts in their effort to understand the impact of fiscal and monetary policies on the stock return expectations of individual investors, but they should consider both fiscal and monetary policy decisions and their interactions together rather than in isolation.