Monetary policy and fiscal policy refer to government policies and tools used to control macroeconomic variables as well as financial markets. Whenever economic activities start to slow, these tools are used to accelerate growth. Similarly, when the economy starts to overheat, they play the role of moderating inflation.
Both monetary and fiscal policies have an overall objective of creating an economic environment where growth is not only positive but also stable. Inflation should be stable and low. In such a good economic environment, corporations can focus on their investment decisions; hence, maximizing profits for their shareholders while households can feel secure with their savings.
Generally, monetary policies refer to the actions of a central bank with regards to determining or influencing the money supply within the economy. Also, one of the major objectives of the policy is to ensure financial stability 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 bank rate variation policies, open market operations, changes in reserve ratios, and selective credit controls.
- The distribution of wealth and income among 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 fiscal policy’s primary goal is controlling the economy of a given country through influencing the total national output (GDP).
Similarities between Monetary Policies and Fiscal Policies
- They are both macroeconomic tools;
- They are policies geared toward 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 policy-makers of the government through laws.
- Monetary policies use tools such as a bank rate variation policies, open market operations, changes in reserve ratios, and selective credit controls for implementation, while fiscal policies use tax and government expenditure as tools for implementation.
Which of the followings cannot be an instrument of monetary policy?
A. Change in reserve ratios
B. Decisions about taxation and spending
C. Open market operations
The correct answer is B.
Decisions about taxation and spending is a tool used in fiscal policy through government policies. Changes in reserve ratios, open market operations, selective credit controls, and bank rate variation policies are all monetary policies.
Reading 18 LOS 18a:
Compare monetary and fiscal policy.