Moneytary and Fiscal Policy
Moneytary and Fiscal Policy
Moneytary and Fiscal Policy
Monetary policy and fiscal policy refer to the two most widely recognized tools used
to influence a nation's economic activity. Monetary policy is primarily concerned
with the management of interest rates and the total supply of money in circulation
and is generally carried out by central banks, such as the U.S. Federal Reserve.
Fiscal policy is a collective term for the taxing and spending actions of governments.
In the United States, the national fiscal policy is determined by the executive and
legislative branches of the government.
Fiscal policy refers to the government’s decisions about taxation and spending.
Both monetary and fiscal policies are used to regulate economic activity over time.
They can be used to accelerate growth when an economy starts to slow or to
moderate growth and activity when an economy starts to overheat. In addition, fiscal
policy can be used to redistribute income and wealth.
Fiscal policy relates to government spending and revenue collection. For
example, when demand is low in the economy, the government can step in and
increase its spending to stimulate demand. Or it can lower taxes to increase
disposable income for people as well as corporations.
These methods are applicable in a market economy, but not in
a fascist, communist or socialist economy. John Maynard Keynes was a key
proponent of government action or intervention using these policy tools to
stimulate an economy during a recession.
Fiscal policy refers to the tax and spending policies of the federal government. Fiscal
policy decisions are determined by the Congress and the Administration; the Fed
plays no role in determining fiscal policy.
Monetary policy refers to central bank activities that are directed toward influencing
the quantity of money and credit in an economy. Monetary policy relates to the
supply of money, which is controlled via factors such as interest rates and reserve
requirements (CRR) for banks. For example, to control high inflation, policy-makers
(usually an independent central bank) can raise interest rates thereby reducing
money supply.
Monetary policy refers to the actions of central banks to achieve macroeconomic
policy objectives such as price stability, full employment, and stable economic
growth.
The U.S. Congress established maximum employment and price stability as the
macroeconomic objectives for the Federal Reserve; they are sometimes referred to
as the Federal Reserve's dual mandate. Apart from these overarching objectives, the
Congress determined that operational conduct of monetary policy should be free
from political influence. As a result, the Federal Reserve is an independent agency of
the federal government.
The Federal Reserve uses a variety of policy tools to foster its statutory objectives of
maximum employment and price stability. Its main policy tools is the target for the
federal funds rate (the rate that banks charge each other for short-term loans), a key
short-term interest rate. The Federal Reserve's control over the federal funds rate
gives it the ability to influence the general level of short-term market interest rates.
By adjusting the level of short-term interest rates in response to changes in the
economic outlook, the Federal Reserve can influence longer-term interest rates and
key asset prices. These changes in financial conditions then affect the spending
decisions of households and businesses.
The monetary policymaking body within the Federal Reserve System is the Federal
Open Market Committee (FOMC). The FOMC currently has eight scheduled
meetings per year, during which it reviews economic and financial developments and
determines the appropriate stance of monetary policy. In reviewing the economic
outlook, the FOMC considers how the current and projected paths for fiscal policy
might affect key macroeconomic variables such as gross domestic product growth,
employment, and inflation. In this way, fiscal policy has an indirect effect on the
conduct of monetary policy through its influence on the aggregate economy and the
economic outlook. For example, if federal tax and spending programs are projected
to boost economic growth, the Federal Reserve would assess how those programs
would affect its key macroeconomic objectives--maximum employment and price
stability--and make appropriate adjustments to its monetary policy tools.
Monetary policy and fiscal policy are two different tools that have an impact on the
economic activity of a country.
Monetary policies are formed and managed by the central banks of a country and
such a policy is concerned with the management of money supply and interest rates
in an economy.
Fiscal policy is related to the way a government is managing the aspects of spending
and taxation. It is the government’s way of stabilising the economy and helping in the
growth of the economy.
Governments can modify the fiscal policy by bringing in measures and changes in
tax rates to control the fiscal deficit of the economy.
Below are certain points of difference between the monetary and fiscal policy
Monetary Policy Fiscal Policy
Definition
It is a financial tool that is used by the central banks It is a financial tool that is used by the central
in regulating the flow of money and the interest rates government in managing tax revenues and policies
in an economy related to expenditure for the benefit of the economy
Managed By
Measures
It measures the interest rates applicable for lending It measures the capital expenditure and taxes of an
money in the economy economy
Focus Area
Exchange rates improve when there is higher interest It has no impact on the exchange rates
rates
Targets
Monetary policy targets inflation in an economy Fiscal policy does not have any specific target
Impact
Monetary policy has an impact on the borrowing in Fiscal policy has an impact on the budget deficit
an economy
Monetary policy involves changing the interest rate and influencing the
money supply.
Fiscal policy involves the government changing tax rates and levels of
government spending to influence aggregate demand in the economy.
They are both used to pursue policies of higher economic growth or controlling
inflation.
Monetary policy
Monetary policy is usually carried out by the Central Bank/Monetary
authorities and involves:
1. To increase demand and economic growth, the government will cut tax
and increase spending (leading to a higher budget deficit)
2. To reduce demand and reduce inflation, the government can increase
tax rates and cut spending (leading to a smaller budget deficit)
This shows that in 2009/10 the UK ran a budget deficit of 10% of GDP. This
was caused by the recession and also the government’s attempt to provide a
fiscal stimulus (VAT tax cut) to try and get the economy out of recession.
If the government felt inflation was a problem, they could pursue deflationary
fiscal policy (higher tax and lower spending) to reduce the rate of economic
growth.
However, the recent recession shows that monetary policy too can have many
limitations.