Introduction:
Monetary and fiscal policies are the two tools that a government and central bank use in controlling an economy of a country. Though aimed at the same objectives, stabilizing the economy and promoting growth while minimizing unemployment, these both policies do so differently. The monetary policy is the weapon adopted by a central bank in a country to control its money supply and interest rates. However, fiscal policy is regulated by the government via spending and taxation. Here’s how the two policies compare in making a difference in the economy of the country.
What is Monetary Policy?
This refers to the set of actions the central bank can perform to control money supply and, consequently, interest rates; in some cases, inflation. Central banks’ use of monetary policy aims at achieving a stable economy while keeping unemployment and inflation in reasonable numbers. There are three major tools used by central banks for the purpose of monetary policy.
1. Interest Rates: Interest rates upon alteration of which the short-run interest rates affect the rates of borrowing and lending for the entire economy. Economic growth is boosted through stimulating spending by making borrowing affordable once these banks lower the interest rates or raise them, thus repressing spending and inhibiting inflation.
2. Open Market Operations: The central bank purchases or sells government securities in order to expand or contract the money supply. Buying securities injects more money in the economy, which dampens the interest rates and boosts spending. Selling securities withdraws the money supply and raises interest rates.
3. Reserve Requirements: Reserve requirements are the share of money that a commercial bank has to keep in reserve and its permitted lending percentage. A decrease in reserve requirements increases the money available for lending that goes on to fuel economic activities, whereas an increase in reserve requirements decreases lending and, subsequently, spending to prevent inflation.
In principle, the monetary policy is rather a circle. During a period of recession, the interest rate is declined to strengthen the economy whereas during a time of booms it fights with inflation. It’s even relatively short and easily amendable when matters change, leaving an elbow-room for a response to its condition in economy.
What is Fiscal Policy?
Fiscal policy can be defined as that monetary tool employed by the government through spending and tax policies thereby changing the state of economic conditions. Decisions about fiscal policy are generally decided by the government, but, in most cases, indicate what the government has at stake on economic matters as well as its social policy. Some of the major objectives of fiscal policy are bringing an increase in economic activity, reducing unemployment, and containing inflation. Fiscal policy may broadly be classified under two heads.
1. Government Spending: An enhancement of the government’s spending on infrastructure, education, health, and the like injects money directly into the economy. It can provide jobs and also stimulate demand. It is termed as expansionary fiscal policy, which is normally used during the recession period to stimulate economic activities.
2. Taxes: Tax rates change the money that people and business organizations have to spend. Lower taxes increase disposable income, which increases the incentives for spending by individuals and business organizations and therefore speeds up economic growth. Higher taxes, on the other hand, can slow down spending and sometimes are used to reduce inflation.
Fiscal policy is generally operated in the context of a plan over a longer period of time. It takes many months to roll out since it involves legislation, but affects income distribution, economic priorities, and social objectives. In contrast with monetary policy, which remains largely focused on interest rates and inflation, fiscal policy will focus more on resource allocation and how the economic environment can be crafted in certain ways.
KEY DIFFERENCES BETWEEN MONETARY AND FISCAL POLICIES:
1. Control and Implementation
Monetary Policy: Carried out by the central bank. It is not controlled by any government policy. The implementation of a change remains independent on the part of the central bank as well.
Fiscal Policy: Is carried out through government control but usually subjected to legislative legislation before any implementation. Governmental decisions regarding spending and taxation lie in other economic and social issues.
2. Tool Used:
Monetary Policy: Interest rate, open market operations and reserve requirements for varies money supply and to affect borrowing costs.
Fiscal Policy: Higher government expenditure and higher tax rates increase aggregate demand.
3. Speed of Implementation:
Monetary Policy: Changes in the interest rates or the level of reserve requirements can be made relatively quickly so that a central bank can respond quickly to changes in the economy, almost in real time.
Fiscal policy: takes more time to implement, especially if legislative approval is necessary. Fiscal measures mostly come as part of the annual budget and are long-run in effect.
4. Direction of Each Policy
Monetary policy: affects the overall level of prices by controlling inflation and determining interest. Its main application is to govern the business cycle through which an economy can be re-energized or dampened.
Fiscal Policy: Major goal is economic growth, unemployment, and income distribution. Most often, fiscal policy finds applications in structural problems as are the cases of income inequality, welfare, etc.
5. Impact on Economy
Monetary Policy: More direct influence on the cost of borrowing, demand curve of consumer spending, and prices. Financial markets as well as short-run interest rate are impacted directly.
Fiscal Policy: Affects level of infrastructure, employment as well as public services directly. Economic growth rate will have some influence, but a more direct effect can be experienced over sectors.
When Do They Apply?
The monetary and fiscal policies both get applicable under different circumstances.
Recession: In case of recession, the central bank may lower interest rates to increase borrowing while the government would increase its expenditures or reduce taxes to raise demand and thus employ people.
Inflationary Periods: The central bank can raise interest rates to restrain increasing inflation by making borrowing costly. The government may curtail spending or raise taxes to reduce the amount of money available for circulation within the economy
Boom Periods: In the boom period, both policies are usually non-accommodative or little restrictive in order not to overheat the economy.
Conclusion:
Monetary and fiscal policies are two different weapons that are usually implemented together for countering economic challenges. A central bank can low interest rates so that it becomes cheap to borrow whereas the government increases spending to finance job creation and infrastructure ventures. Understanding the differences between the two policies is essential for the right interpretation of economic developments and policymaker decisions. Monetary and fiscal policies together strike a balance for promoting economic stability, management of inflation, and sustainability.