Monetary vs. Fiscal Policy

Monetary and fiscal policies are economic terms we hear on business news, read in papers, or learn in economics classes. Nevertheless, what do they mean?

In modern society, every advanced country attains sustainable growth through a direct approach to revenue accrual, budgeting, spending, money regulations, interest rates, and policies that manage demand and supply. All these make monetary and fiscal policy essential for every nation. As influential and correlated as both terms are, they have distinct meanings.

What Is Monetary Policy?

Monetary policy is a macroeconomic tool that a country's central bank or financial authorities adopt to regulate economic growth, prices of goods and services, and credit availability. Because it is macroeconomic in concept, it affects a region, nation, continent, or the globe.

The government of a nation applies monetary policies to control the circulation of money and interest rates in the country. It involves the increase or decrease of interest rates by the central bank. For example, a nation might be experiencing prevailing unemployment, widespread poverty, a recession, and a need for development. In that case, the government may cut interest rates so that citizens and residents can access loans for capital investments and reduce the cost of goods and services. This act is called expansionary monetary policy.

If there is a waste of resources, inflation, and over-accelerated economic growth, contractionary monetary policies, which are the opposite of expansionary monetary policies, are used to salvage the economy.

Monetary policy controls how individuals and businesses borrow, spend, save, and invest in an economic cycle. It also helps to prevent a recession in the long run.

What Is Fiscal Policy?

In modern times, when you hear the word fiscal policy, two things should come to mind: revenue (through taxation) and spending or expenditure. Fiscal policy is the increase or decrease of governmental taxation and expenditure from its treasury.

When there is a need to accelerate economic growth or curtail recession, the government increases its budgets and spends on activities that stimulate business growth. This action is called expansionary fiscal policy. For example, after the Great Recession of 2007–2009, the American government spent about $831 billion to finance the 2009 American Recovery and Reinvestment Act. The government used this fiscal policy to stimulate the economy by establishing healthcare, educational, and infrastructural facilities and tax reductions.

Fiscal policy also regulates the consumption of certain commodities in a country. For example, a government may increase taxes on the importation of certain goods to encourage local production and consumption of the same product. The government may curb inflation through fiscal policies. It involves increasing taxes to raise revenue for developmental budgets and reduce consumer spending. It is called contractionary fiscal policy.

Difference Between Monetary Policy and Fiscal Policy

Here are four significant differences between monetary policy and fiscal policy:

1. Monetary policy involves managing economic activities, while fiscal policy is the taxation and expenditure of a nation.

2. Monetary policy addresses how the central bank supplies money in an economy and the effect of the increase and decrease of interest rates, while the central focus of fiscal policy is taxation and spending.

3. Monetary policy is primarily non-political, autonomous, and initiated by a country's central bank or financial authority. In contrast, fiscal policy involves the government's legislative and executive arms.

4. Fiscal policy includes subsidies, tax relief, indirect taxes, expenditure, and welfare payments in a country. Monetary policy may include buying and selling Treasury bonds, discount rates, and banks' reserve ratios.

Conclusion

Monetary and fiscal policies help influence economic growth and increase the wealth of a nation. They help tackle economic issues such as recession, inflation, unemployment, and poverty.