Economics

Question

Difference between fiscal and monetary policy

Aakanksha29 · Answer

The difference between fiscal policy and monetary policy are as follows-:1. Monetary policy refers to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. Fiscal policy refers to the tax and spending policies of the federal government.2. 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.3. Monetary policy is usually carried out by central bank or monetary authorities and involves setting base interests (e.g. England bank in UK).Fiscal policy is usually carried out by government. Working of both policies-:Monetary policy - • The central Bank may have an inflation target of 4%. If they feel inflation is going to go above the inflation target, due to economic growth being too quick then they will increase interest rates.• Higher interest rates increase burrowing costs and reduce consumer spending and investment leading to lower aggregate demand and lower inflation.• If the economy went into recession, the Central Bank would cut interest rates.Fiscal policy-• To increase demand and economic growth, the government will cut tax and increase spending (leading to a higher budget deficit).• To reduce demand and reduce inflation, the government can increase tax rates and cut spending (leading to a smaller budget deficit).

colas0919 · Answer

Both fiscal and monetary policy are key in regulating a country's macroeconomics.Fiscal policy is action taken by changes in tax and spending of the government. This is usually done in order to return the economy to a more stable state. This is based on Keynesian economics, in which the government can make changes to the macroeconomic state of the country. 
The government could either decrease tax levels and increase government spending, or they could increase tax levels and decrease government spending. The former is done when there is a recession, where unemployment is high and wages are low. Decreasing taxes gives people more money to spend, which would then stimulate the economy. Increasing government spending also creates more jobs, like in construction, which would also increase the amount of money supply. With more money, people's demand for stuff will increase, and then businesses will make more money so the economy will escape this recession. This is called expansionary fiscal policy.
When this process goes on for too long, then inflation would be extremely high. This is when the government decides to increase taxes and decrease government spending. The aim of this is to decrease the amount of money supply so inflation levels decrease. This is called contractionary fiscal policy. These two things are constantly done to balance out the economy. 
Monetary policy is action that is taken by the country's central bank, like the Federal Reserve, to also control the money supply. There are three main tools: changing the reserve requirement, open market operations, and changing the discount rate.
The reserve requirement is the required amount of money other banks are supposed to have at all times. Increasing this would decrease the money supply, which is done when there is an inflationary economy (too much inflation). This is done as part of a contractionary policy. Decreasing reserve requirement is done to increase the money supply. With more money, the banks can use it for loans or other assets, and the opposite is true when the reserve requirement is increased. 
Open market operations are done when the Fed buys or sells bonds. When the Fed buys bonds, they release more money into the money supply, and then banks can then use that money for loans at lower rates. This is done in an expansionary policy. If the Fed sell bonds, they decrease the money supply, so banks would lend money at higher rates. This is done in a contractionary policy.
The discount rate is the interest rate that the Fed charges commercial banks that borrow from the Fed. Decreasing the discount rate would mean that commercial banks would have to worry less about loans, take more risks, and also operate with lower reserves. This is done in an expansionary policy. When the discount rate increases, banks need to be more conservative about their lending and thus, decrease the money supply. This is done in a contractionary monetary policy.

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