Compare Monetary and Fiscal Policy

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 good economic environment, corporations can focus on their investment decisions; hence, making profits for their shareholders while households can feel secure in their consumption and savings.

Monetary Policies

Generally, monetary policies refer to actions of a central bank with regards to determining or influencing the quantity of money in circulation and credit within the economy (money supply). Also, one of the major objectives of the policy is to ensure financial stability and also stability in payment systems. Additionally, it plays the role of ensuring price stability.

Instruments of monetary policies

Monetary policies use quite a number of instruments through central banks to accomplish its objectives. Some of them include bank rate variation policy, open market operations, changes in reserve ratios, and selective credit controls.

Fiscal policies

Fiscal policies refer to government decisions about taxation and spending. These decisions affect a number of factors in the economy, including:

  1. Distribution of wealth and income among different parts of a country
  2. Allocation of resources in all sectors of the economy
  3. The aggregate demand of goods and services and, therefore, the level of economic activity

Roles and objectives of fiscal policies

A fiscal policy has a primary goal of controlling the economy of a given country through its influence on 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.
  • 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 law, policies-making body of the government.
  • Monetary policies use tools such as a bank rate variation policy, open market operations, changes in reserve ratios, and selective credit controls for implementation, while fiscal policies uses tax and government expenditure as tools for implementation

Question

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

Solution

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.

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