Question

Compare Monetary policy and Fiscal policy. What is the purpose for using them, and what are the tools used in each? How can either or both be used for achieving macroeconomic goals?

Answer 1

INTRODUCTION TO MONETARY AND FISCAL POLICIES-

Monetary policy is implemented by the central bank of a country while the fiscal policy is implemented by the government of the nation. Both of these policies works as a controlling hands to influence the performance of an economy generally in short run period. Both are used to achieve macroeconomic goals via controlling the economic activities through its various tools.

Like government spending which is done in case of depression to generate demand and inject money in the economy and as well to provide social services to public and other defence and R and D projects for a nations development. While with taxation government generates income and as well imposes certain taxes to kill demand of some goods in order to promote other. Like costom and excise duties to control imported goods demand and on the other hand tax reliefs to domestic products to boost domestic economic activities.

Monetary Policy on the other hand through controlling money supply and interest rates helps in achieving macroeconomic goals like controlling unemployment and inflation. Like by lowering interest rates it can reduce the cost of borrowing which will boost capital demand by industries and hence improve productive activities, raising employment rates.

Note: Comparison between the policies and their macroeconomic significance are understood together with the explaination of the policies.

FISCAL POLICY AND IT'S PURPOSE-

Fiscal Policy is a means to the government through which it manages it's expenditure and taxation. This is used to stabalize the economy. It is based upon the Keynesian economics given by J.M. Keynes after the great depression. Here government through its expenditure and taxation policies enjoys the power to boost economic activities by injection of more money through expenditure and as well sectoral controlling by implementing taxation. Like it can impose heavy taxes or reduce taxes in order to either promote or regulate specific business. In a nutshell it a policy of government with namely two components via which it controls economic activities of the nation.

1- Government Taxation- By imposing tax government earns revenue as well take control over economic activities.

2-Government Expenditure- Government spends boost economic activities via generation of aggregate demand and supply public services.

MONETARY POLICY AND IT'S PURPOSE-

Monetary policy is controlled by the Central Bank of a nation. It is a sister policy to Fiscal. This policy is too used to influence the economic activities in a nation. But the tools and the controlling body is different in case of this policy from Fiscal policy. This policy ensures how the Central Bank manages the liquidity in the country. By liquidity we mean money supply. The prime or main objective of the central bank via this policy is to cure the macroeconomic problems like unemployment, interest rate and inflation. Central Bank manages money supply in an economy through various tools. The main are-

1- (OMO) Open Market Operations- It means the selling and buying of government owned securities to increase and decrease the amount of money in an economy. It is the most frequently used tool.

2- Reserve Requirements- Central Bank can command reserve requirements limits which a commercial bank must have to keep of its assets or deposits. This influences liquidity with commercial banks hence influence the lending and borrowing rates which finally results in contraction and expansion of money supply in the economy. Higher reserve requirements is inversely proportional to the liquidity hence money supply.

3- Repo and Reverse Repo Rates- Rates at which Central Bank lend money to commercial banks and the rates at which Central Bank borrows from commercial banks. It is practiced in countries like India.

4- Interest Rate Adjustments- Central Bank controls interest rates by altering discount rates. Higher discount rates leads to higher cost of borrowing for commercial banks from central bank and vice versa.

Thank You.