Monetary and fiscal policy and economic terms applied in day-to-day life activities. They are different from each other in several ways. For instance, monetary policy comprises of drafting, announcing, and implementing the plan of action taken by financial authorities in a country. On the contrary, fiscal policy acts as a guide that aids a government on deciding what amount of funds to spend. Therefore, this paper seeks to explain the major differences between the two.
Monetary policy is an economic policy that aims at bringing price stability and controlling inflation, while fiscal policy aims at preventing unemployment and inflation. Monetary policy is set by the central bank or federal reserve of a country while fiscal policy is set or controlled by the government, especially finance. Besides, interest rates tools are used in monetary policy; they can either be reduced or increased according to the economic situation. In fiscal policy, government spending and taxes are tools used to influence the financial crises.
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Monetary policy is set independently by the federal bank reserves; hence it does not suffer from political influence; therefore, the politician does not reduce the interest rate to have more money to be used in campaigns before elections (Braude & Flug, 2012). In contrast, fiscal policy is mainly affected by politics since its set by the government of a country, leads to tax and government spending changes.
Fiscal policy has a high liquidity trap because it can be used in a deep recession. After all, government spending causes demand. This may help kick-start the economy out of recessions. In contrast, in monetary policy, a reduction in interest rate does not work in a liquidity trap because the banks may not lend money. Consumers are too nervous about spending during a recession.
Conclusively, monetary policy involves increasing money supply into the economy by reducing interest rates, leading to the capital formation process, for example, investment. On the other hand, the fiscal policy comes about due to government spending and taxation policy that either increases or reduces aggregate demand in an economy.
Reference
Braude, K., & Flug, K. (2012). The interaction between monetary and fiscal policy: insights from two business cycles in Israel. BIS Paper , (67o).
