Question

What are the similarities and differences between fiscal policy and monetary policy?

Answer 1

Similarities between monetary and fiscal policies:-

Both the monetary and fiscal policies have the same goal of reducing cyclical fluctuations in the economy. Though both policies i.e monetary and fiscal policies are implemented by central bank and government respectively, they both are used to stimulate an economy during recession and control the economy by controlling money supply during inflation. Full employment growth rate and positive economic growth rate are main priority of both the policies.

Differences between monetary and fiscal policies:-

  Fiscal policy is the mechanism where government makes changes in their taxation and spending in order to influence aggregate demands and activities in the economy while monetary policy is implemented by the central bank of a country which manages the money supply by increasing or decreasing the interest rates in an economy.

Government increases or decreases taxation system and its spending depending on the economic condition in fiscal policies. Government applies expansionary fiscal policy during the recession period to stimulate economic growth by decreasing taxes and increasing government expenditures in order to expand money supply in the economy. On the other hand;in order to defeat inflation, government increases taxes and cuts down its expenditure in order to lower the money supply rate in the economy which is called as contractionary fiscal policy. In monetary policy; interest rates are increased or decreased by the central bank to control the money supply. Lowering interest rates leads to the increase of money supply in the economy which increases the aggregate demand and higher GDP which is called expansionary monetary policy. On the other hand,central bank raises interest rates in order to fight inflation which make lending more expensive and reduces the money supply in the market. This is called as contractionary monetary policy.