When discussing the economy and the actions of government the terms fiscal policy and monetary policy often come up. These refer to two distinct forms of policy, however, and it’s important to understand what the goals of each are and who sets those policies.
Fiscal policy is managed by governments, in the U.S. the President and Congress, and refers to the revenue-generating and spending policies that the government implements. Effectively, fiscal policy becomes the aggregate of many smaller policies that all relate to different taxation and spending issues that the government has provided direction on.
Governments can increase or decrease taxes, which would impact the revenues the government generates to fund itself and would be considered part of the government’s fiscal policy.
Alternatively, the government can increase or decrease social spending in different areas, which impacts the expenses of the government and would be considered part of its fiscal policy.
Fiscal policy is very much influenced by current politics and can vary greatly. Additionally, because taxes and spending can be very specific or directed, changes in fiscal policy can be targeted to specific groups of individuals or companies.
Monetary policy is managed by a government’s central bank, in the U.S. the Federal Reserve, which is a distinct difference in terms of responsibility. Fiscal policy can vary widely due to the actions of congress, whereas monetary policy is far more established and centrally managed. In the U.S. it was determined that this was an important distinction to make to ensure that monetary policy was not overly subject to political influence.
Monetary policy also focuses on policies that impact key areas of the economy like price stability (inflation), employment rates, and stable economic growth. Government typically sets ranges for the central bank to aim for in terms of economic performance and the central bank tailors its policies to achieve those ranges.
The main tools of monetary policy are setting interest rates and the actual printing of money. Both can be used to either trigger growth in the broad economy or slow down the economy. Some may wonder why slowing down the economy would be done but in cases where spending or inflation is too high, it can be in the country’s best interests to slow things down. Growth can sometimes be overheated and more ‘paper’ growth than actual underlying growth due to high spending or inflation. These can have negative consequences if not reigned in, as the 2008 financial crisis showed many around the world.
Fiscal policy and monetary policy really complement each other, both having significant impacts on the economy and the daily lives of people and companies. Monetary policy is generally far broader in terms of the tools being used in monetary policymaking impacting the overall economy in general. Fiscal policy, while a broad aggregate of many policies, has tools that can have impacts on precise aspects of the economy or specific groups of individuals and companies. In this overall sense monetary policy is the broad tool for the economy, while fiscal policy provides smaller and more specific tweaks to the economy.