Fiscal Policy vs Monetary Policy [Key Differences]

What is Fiscal Policy?

Central banks have always utilized monetary policy to either boost or restrain an economy's growth. The goal of monetary policy is to stimulate economic activity by motivating individuals and firms to borrow and spend. Monetary policy, on the other hand, can act as a brake on inflation and other ills associated with an overheated economy by constraining expenditure and rewarding savings.

The Federal Reserve, generally known as the "Fed," has influenced the economy with three primary policy tools: open market operations, adjusting bank reserve requirements, and setting the discount rate. The Federal Reserve buys and sells government bonds on a daily basis in order to either inject money into the economy or remove money from circulation. The Fed directly controls the quantity of money created when banks issue loans by adjusting the reserve ratio, or the percentage of deposits that banks must maintain in reserve. Changes in the discount rate (the interest rate the Fed charges on loans to financial institutions) can also be targeted by the Fed, with the goal of influencing short-term interest rates across the economy.

Monetary policy is a blunt weapon for influencing inflation and growth by expanding and decreasing the money supply, and it has little impact on the real economy. During the Great Depression, for example, the Fed was forceful. Its actions averted deflation and economic collapse, but they failed to generate enough growth to compensate for the lost output and jobs.

What is Fiscal Policy?

Most government fiscal policies try to reduce the total composition of spending, the total amount of expenditure, or both in a given economy. Changes in government spending policies and changes in government tax policies are the two most common ways to influence fiscal policy.

If a government decides there isn't enough commercial activity in a given economy, it can raise spending, which is known as stimulus spending. If tax revenues are insufficient to cover spending increases, governments start the process of deficit expenditure. They borrow money by issuing debt securities such as government bonds, accumulating debt in the process.

When a government decides to spend money or change its tax policy, it must decide where to spend it and what to tax. Government fiscal policy can target certain areas, industries, investments, or commodities in this way to either encourage or discourage production—and its actions are sometimes motivated by factors other than economic ones. As a result, fiscal policy is frequently a source of heated dispute among economists and political analysts.

In essence, it is aiming for total demand. Companies profit from greater revenues as well. If the economy is at full capacity, however, expansionary fiscal policy runs the danger of causing inflation. Inflation takes away at the margins of some businesses in competitive industries that may not be able to pass on costs to customers as easily as others; it also eats away at the savings of persons on a fixed income.

Monetary Policy VS Fiscal Policy

Both monetary and fiscal policy play a prominent role in economic management, with direct and indirect effects on personal and household finances. Fiscal policy refers to the government's spending decisions along with taxation, which affect people' tax bills or offer jobs through government programs. The central bank sets monetary policy, which can promote consumer spending by lowering interest rates, making borrowing on everything from credit cards to mortgages more affordable.