Fiscal Vs Monetary Policy
Below is the Difference Between Monetary and Fiscal Policy:-
The monetary policy allows there to be liquidity in the economy and the economy remains stable throughout. On the other hand, the fiscal policy warrants that the economy grows and develops through the government’s revenue collections and government’s suitable expenditure.
Monetary policy is created according to the economic conditions of the country. Fiscal policy is created every year after evaluating the outcomes of the previous year.
Monetary policy is actually a subset of fiscal policy. Whereas, the fiscal policy ensures the overall well-being of the economy.
Monetary policy is controlled by the central bank of the country. Fiscal policy on the other hand, is controlled by the country's ministry of finance.
Monetary policy does not impose any political influence. Fiscal policy on the other hand, possesses reasonable political influence.
Difference Between Fiscal and Monetary Policy
Following is a comparison table of Fiscal vs. Monetary Policy:-
How Monetary Policy Works?
The Central Bank has an inflation target of 2%. If they feel inflation is going to rise above the inflation target, because of economic growth being too quick, then they will surge interest rates.
Higher interest rates increase borrowing costs and decrease consumer spending and investment, resulting in lower inflation and lower aggregate demand.
If the country’s economy went into recession, the Central Bank of the country would cut interest rates.
Which is More Effective Monetary or Fiscal Policy?
Apart from difference between fiscal and monetary policy, monetary policy in recent decades has become more popular because:
Monetary policy is issued by the Central Bank, and thus minimizes political influence (e.g. politicians may cut interest rates in the wake to have a booming economy ahead of a general election)
Fiscal policy can impose more supply side effects on a larger economy. E.g. to minimize inflation – higher tax and lower spending would not be well-liked, and the government may be unwilling to pursue this. In addition, lower spending could result in reduced public services, and higher income tax could cause disincentives to work.
Monetary policy is much faster to execute. Rate of interest can be set every month. A decision to raise government spending may take time to gauge where to spend the money.
Expansionary fiscal policy (for e.g. higher government spending) may result in special interest groups thrusting for spending which isn’t really useful and then proves complex to reduce when the recession is over.
Conclusion
Both are quite significant for the growth and development of a country’s economy. But they have several applications as well as merits and demerits. The fiscal policy caters to the country through its collections of money and the appropriate expenditure. If the fiscal policy fails, it will also impact the monetary policy of the company.
FAQs on Difference Between Monetary Policy and Fiscal Policy
1. What is Fiscal and Monetary Policy?
Answer: Fiscal policy is conducted by the government and involves changing:
Levels of taxation and government spending
To surge demand and economic growth, the government will deduct tax and increase spending (leading to a greater budget deficit)
To decrease demand and minimize inflation, the government may increase tax rates and cut spending (resulting in a smaller budget deficit)
On the other hand, monetary policy is generally conducted by the Central Bank/Monetary authorities and involves:
Establishing base interest rates (e.g. Federal Reserve in the US and Bank of England in UK)
Governing the supply of money. (E.g. Policy of quantitative easing to rise the supply of money).
2. What are the Limitations of Monetary Policy?
Answer: The recent recession displays that monetary policy has many limitations:
Targeting inflation is too tapered. During 2000-2007, inflation has been low but central banks disregarded an unsustainable boom in the bank lending and housing market.
Liquidity trap during recession, deducting interest rates may prove inadequate to encourage demand since banks don’t want to lend and consumers are too anxious to spend.
In a liquidity trap, expansionary fiscal policy will not induce crowding out since the government is making use of surplus savings to administer demand into the economy.
Even quantitative easing that creates money may be ineffective if banks just want to reserve extra money on their balance sheets.
Government spending creates direct demand in the economy and can offer a rekindle to bring the economy out of recession. Therefore, in a deep recession, depending on monetary policy alone, may be inadequate to restore balance in the economy.
During a deep recession, expansionary fiscal policy may be significant for confidence – if monetary policy has turned out to be a failure.
