Monetary policy vs fiscal policy

Santosh Neupane

Monetary policy and fiscal policy refer to the two most widely recognized tools used to influence a nation´s economic aftivity. Monetary policy is primarily cncerned with the management of interest rates and the total supply of money in circulation and is generally carried out  by central banks such as the NRB. Fiscal policy is the colletive term for the taxing and spending actions of governments. In the Nepal, the national fiscal policy is determined by the executive and legislative branches of the government.

Monetary Policy:-

Central banks have typically used monetray policy to either stimulate an economy or to check its growth . The theory is that, by incentivizing individuals and businesses to borrow and spend, monetary policy can spur economic activity. Conversely, by restricting spending and incentivizing savings , monetary policy can act as a brake on inflation and other issues associated with an overheated economy.

Which is more Effective: Monetary or Fiscal Policy ?

In terms of improving the real economy , expansionary fiscal policy is more effective. In terms of the financial economy , expansionary monetary policy is the better choice. Both types work through different channels and impact individuals and corporations in different ways. Fiscal policy affects consumers positively for the most part, as it leads to increased employment and income. Essentially, it is targeting aggregated demand. Companies also benefit as they see increased revenues.

However, if the economy is near full capacity, expansionary fiscal policy risks sparking inflation. This inflation eats away at the margins of certain corporations in competitive industries that may not be able to easily pass on costs to customers; it also eats away at the funds of people on a fixed income. Fiscal policy can also have the effect of creating asset bubbles if the market and incentives become too distorted.

Monetary policy has less impact on the real economy. Case in point: the Great Depression, during which the Federal Reserve was particulary aggresive on a historical scale. Its actions prevented deflation and economic collapse but did not generate significant economic growth to reserve the lost output and jobs.

Expansionery monetary policy can have limited effects on growth by increasing asset prices and lowering the cost of borrowing, making companies more profitable . In addition , it has the psychological benefits of taking worse-case economic senarios off the table. As with fiscal policy, extended periods of low borrowing  costs can create asset bubbles that are only apparent in hindsight. Another crucial difference between the two is that fiscal policy can be targeted , while monetary policy is more of a blunt tool in terms of expanding and contracting the money supply to infulence inflation and growth. Fiscal policy is how elected officials influence the economy using spending and taxation. It is used in conjunction with the monetary policy implemented by central bank. It influences the economy using the money supply and interest rates.

 

Key Differences between MP & FP

• The policy of the government in which it utilises its tax revenue and expenditure policy to influence the aggregate demand and supply for products and services the economy is known as fiscal policy . The policy through which the central bank controls and regulate the supply of money in the economy is known as Monetary Policy.
• Fiscal policy is carried out by the ministry of finance whereas the monetary policy is administered by the cenral bank of the country.
• Fiscal policy is made for a short duration , normally one year, while the monetary poilcy lasts longer.
• Fiscal policy gives direction to the economy . On the other hand, Monetary policy brings price stability .
• Fiscal policy is concerned with government revenue and expenditure , but monetary policy is concerned with borrowing and financial arrangement.
• The major instrument of FP is tax rates and government spending. Conversely , interest rates and credit ratios are the tools of MP.
• Political influence is there in fiscal policy. However, this is not in the case of monetary policy.

The main reason of confusion and bewilderement between fiscal policy and monetary policy is that the aim of both policies is same. The policies are formulated and implemented to bring stability and growth in the economy . The most significant difference between the two is that FP is made by the government of the respective country whereas the central bank creates the monetary policy.