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Monetary Policy vs Fiscal Policy Differences

 Monetary Policy vs Fiscal Policy Differences

Read about the importance of monetary policy for a nation. Even though there are differences between monetary and fiscal policy, both are equally important to keep the economy healthy.

Monetary policy and fiscal policy are crucial criteria that decide the fate of the economic status of a nation. Both are important to maintaining equilibrium in the economy. Monetary policy, created by the Federal Reserve, has the power to control the economy by contriving the money input and rates of interest. It plays a vital role in achieving macroeconomic policy and is mainly managed by the Central Bank. 

On the other hand, fiscal policy was created to gain a specific goal using targeted tax income and spending. Government legislation is the main factor that determines fiscal policy. 

Monetary Policy

Monetary policy acts as a macroeconomic policy which is under the control of the Central Bank. The Central Bank controls money input in the economy, impacting interest rates. This interest rate is directly related to gaining different macroscopic goals.

These goals include inflation, consumption as well as growth and liquidity. Hence, monetary policy plays a vital role in maintaining economic growth.

Money supply in the economy and rate of interest change are two critical parameters that affect monetary policy. Different policy tools that affect the economy are:

  • Discount rate,
  • Reserve requirement,
  • Open market operations, and
  • Interest on reserves

Monetary policy stimulates people and firms to invest in various economic activities. Therefore, it has an indirect impact on a country’s economy. As there is very less political interference in monetary policy, it can be acted upon independently.

The main risk here is that if monetary policy becomes loose, it can inversely increase the money supply and inordinately impacts inflation. It functions on the flow of money in the economy and credit control. If we closely observe, monetary policy is highly complex.

Fiscal Policy

British economist John Maynard Keynes (1883-1946) gave the concept of fiscal policy. He stated that the government is responsible for maintaining the business circle and regulating the economic product.

According to Keynesian economics, aggregate demand is a key factor in handling the production and development of the economy. Customers’ spending, different spending during investment, the total expenditure of the government as well as total export value combine and form aggregate demand.

In fiscal policy, government revenue collection and expenditure are used to affect the country’s economic condition. This policy includes the aggregate supply of economic consumption and employment. This also affects economic growth. There is a remarkable impact of changing government spending and tax rates observed in fiscal policy. The government determines the fiscal policy, which shows the direct effect on the economic condition of the country.

Two crucial policy tools that affect fiscal policy are:

  • Taxes, and 
  • Public spending

The credit for a great impact on the economy goes to the tax and spending policies of the federal government. It gives an idea about the money spent by one individual.

Two important types of fiscal policy:

Expansionary Fiscal Policy: In this policy, public expenditure increases, whereas the government decreases taxes.

Contractionary Fiscal Policy: Here, public spending decreases with an increase in taxes by the government.

In fiscal policy, the political influence is very high, affecting the equilibrium of economics. This solid political dimension directly changes the tax rates.

Monetary Policy vs Fiscal Policy

The monetary policy is governed by the Central Bank of the country. On the other hand, fiscal policy is directed by the Finance Ministry.

Monetary policy is performed for a long duration compared to fiscal policy, which is lost for only one year.

Monetary policy plays an important role in maintaining price stability. On the other hand, fiscal policy is responsible for giving a particular direction to the economy.

The political impact on monetary policy is absent. Conversely, there is a significant impact of politics on fiscal policy.

The monetary policy specifically deals with financial management as well as borrowing. Contrarily, fiscal policy comprises government revenue and spending.

The political impact on monetary policy is absent. Conversely, in fiscal policy, there is a major impact of politics on policy.

Economic stability is the main focus of monetary policy compared to fiscal policy, which focuses on the economy’s growth.

The economic status of a nation is directly dependent on the change in monetary policy. On the other hand, fiscal policy gets updated every year.

Conclusion

The objective of monetary policy and fiscal policy is to keep the economy healthy. Both are put together for growth and the steadiness of the economy. The main distinguishing factor between them is that the Central Bank approves monetary policy. On the other hand, fiscal policy is directed by the government of a country. Hence, monetary policy is crucial to achieving macroeconomic policy.