Compare Monetary and Fiscal Policy

Monetary policy and fiscal policy refer to government policies and tools used to control macroeconomic variables and financial markets. Whenever economic activities start to slow down, these tools are used to accelerate growth. Similarly, when the economy starts to overheat, they moderate inflation.

Both monetary and fiscal policies have an overall objective of creating an economic environment where growth is positive and stable. Inflation should be stable and low. In such a good economic environment, corporations can focus on their investment decisions. They can maximize profits for their shareholders. Households, on the other hand, can feel secure with their savings.

Monetary Policy

Generally, monetary policy refers to the actions of a central bank that are aimed at determining or influencing the money supply within the economy. Also, one of the major objectives of monetary policy is to ensure financial and price stability.

Instruments of Monetary Policies

Monetary policies use quite a number of instruments through central banks to accomplish their objectives. Some of them include:

• interest rates;
• open market operations;
• bank reserve requirements; and
• selective credit controls.

Fiscal Policy

Fiscal policy refers to government decisions on taxation and spending. These decisions affect a number of factors in the economy, including:

• the distribution of wealth and income across different parts of a country;
• the allocation of resources in all sectors of the economy; and
• the aggregate demand for goods and services and, therefore, the level of economic activity.

Roles and Objectives of Fiscal Policies

The primary goal of the fiscal policy is to control the economy of a given country by influencing the total national output (GDP).

Similarities Between Monetary Policies and Fiscal Policies

• They are both macroeconomic tools;

• They are policies geared towards the attainment of economic stability and growth; and

• They are both government policies.

Differences Between Monetary Policies and Fiscal Policies

• While monetary policies are government policies implemented through the central bank, fiscal policies are implemented by the government’s policy-makers through laws.

• Monetary policies use tools such as bank rate variation policies, open market operations, changes in reserve ratios, and selective credit controls for implementation. In contrast, fiscal policies use tax and government expenditure as tools for implementation.

Question

Which of the following is least likely an instrument of monetary policy?

A. Change in reserve requirements

B. Decisions about taxation and spending

C. Open market operations

Solution

The correct answer is B.

Decisions about taxation and spending is a tool used in fiscal policy through government policies.

Options A and C are incorrect. Changes in reserve requirements, open market operations, selective credit controls, and bank rate variation policies are all monetary policies.

Reading 16 LOS 16a:

Compare monetary and fiscal policy.