The fiscal policy and monetary policy are the two most important tools that influence the economic activity of the nation. The Fiscal policy is a term that is used for taxing and spending actions of the government. The Monetary policy is concerned with the management of the rate of interest and the supply of money in the economy. It is carried out by Central banks like the U.S. Federal Reserve. Let us take a look at both the policies in detail.

Man holding dollar bills
The Fiscal policy is a term that is used for taxing and spending actions of the government.

Monetary Policy

Banks have used monetary policy in order to grow an economy or to keep a check on the growth. The policy is used to incentivize the citizens and businesses to borrow and spend money. It helps enhance economic activity. By restricting as well as incentivizing savings, the policy works like a brake on inflation. 

The monetary policy is a tool that helps with the expansion and contraction of the money supply to help with growth and inflation in the economy. It has low impact on the real economy. An expansionary monetary policy has minimal effects on the growth by increasing the prices of an asset and reducing the cost of borrowing, thus making more profits for companies.

The monetary policy aims to improve economic activity and the fiscal policy aims to address the total spending or the composition of the spending. 

Fiscal Policy

The purpose of fiscal policies is to target the total level of spending and the total composition of spending. The policy is affected by changes in government spending policies and government tax policies. When the government thinks that there is not adequate business activity in the economy, it increases the amount of money spent and this is known as stimulus spending. 

When there are not adequate tax receipts to pay for the spending, the government will borrow money by issuing debt securities and this is known as deficit spending. The government will accumulate debt to enhance economic activity. 

Whenever the government spends money or makes any changes to the taxation policy, it has to decide where to spend the money and what areas to tax. The policy can aim at different communities or industries to either favor or discourage production. There are various considerations in this decision and the actions are not only economic. Many companies benefit from the changes in the policy as it leads to increase in revenue. If the economy is operating at full capacity, an expansion in fiscal policy can lead to inflation. 

Comparing Fiscal policy and monetary policy

When both the policies are compared, the fiscal policy has a large impact on consumers than the monetary policy. It leads to an increase in income and employment. With an increase in taxes, the government pulls money out of the economy and it slows down business activity. Fiscal policy is used to stimulate the economy. The government may reduce taxes or give rebates in taxes to encourage economic growth.

Both the policies play a significant role in the economy and they have impacts on individual and household finances. The fiscal policy is about spending decisions and tax, as decided by the government. It also has an impact on individuals’ tax bills and provides them with employment from projects undertaken by the government. 

Monetary policy is established by the central bank and helps with consumer spending with a low rate of interest which makes borrowing cheaper. The goal of both policies is to create an economic environment where the growth is positive and stable while the inflation is low but stable. 

Hence, the aim is to drive the economy so that it does not experience booms which could be followed by periods of low or negative growth. With the right environment, citizens will feel secure in their decisions and corporations can focus on their investment decisions. 

Key Takeaways

  • Fiscal policy and monetary policy are macroeconomic tools and they help with economic growth. 
  • The fiscal policy addresses government spending and taxation while the monetary policy addresses the rate of interest and supply of money in the economy. The monetary policy is managed by the Central bank. 
  • The fiscal policy focuses on government spending and education. It is determined by government legislation. 
  • Both  policies are crucial for an economy and have a strong influence on businesses and consumers.
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