At times, we see some news articles in business newspapers that claims that “…the government has made, significant changes in its optimal fiscal and monetary policy…”. But have we ever wondered what the exact meaning of the terms monetary and fiscal policy is! Though these two concepts are parallel, there are some distinguishing factors too. The best way to understand the differences between these two policies is to simplify their constituents.
Many of us know that the term monetary has been derived from the word ‘money’. Monetary policy basically deals in the government functions that are related to money. Many among us believe that the government issues bank notes and coins, and sits back and enjoys the benefits of industrialization and economic growth. This belief is in fact a myth, as there are several different functions that the government fulfills besides issuing the currency. These money-related functions come under the domain of monetary policy of the government. It often includes functions such as maintaining the supply of money on the basis of current economic conditions, maintaining the availability of money by changing the different banking and monetary indexes and also controlling the rates of interest.
The monetary policy of nations is divided into two sub-policies, which are, expansionary policy and contractionary policy. The expansionary policy is usually used during the time of recessionary cycles in order to increase the supply of money. This policy also involves the reduction in rates of interest, which in turn combats the rising rate of unemployment. The contractionary policy is used in order to reduce the effect of inflation, as the rate of interest is increased. To sum up the side of monetary policy, let’s just say that the government policy that influences money, supply of money, circulation of money, and availability and cost of credit is the monetary policy. It must be noted that most of its constituents are implemented by the central bank. Also, this policy is more often used for economic growth.
The fiscal policy is not exactly the contrast of the monetary policy, but just a different policy that is closely associated with the monetary policy of the country. With the important role that the central bank has to play in the implementation of the monetary policy, governments are not left far behind. The role of governments is extremely important too. The fiscal policy is basically the policy of revenue and expenditure that is adopted by the government. This kind of policy basically affects the welfare and economic development that is implemented by the government. It is used as a tool by governments to increase or decrease taxes, and also increase and decrease expenditure of the government, to aid public needs. The policy is usually decided by the finance ministry, department of revenue, and department of corporate affairs. Fiscal policy, thus, directly affects the welfare of the people.
According to the principles that have been laid down by Keynesian economics, fiscal policy can be effectively used to stimulate aggregate demands of the common citizen. Taxation and spending of the government formulated according to the needs of the people, and the aggregate demand and supply for common commodities and civic amenities is a very good fiscal policy. Democratic governments always frame their fiscal policy ‘for the people’.