Monetary and Fiscal Policy

Monetary and fiscal policy refer to the policies of the government aimed to solve the economic problems in a country.
A monetary policy is a credit control measure adopted by the central bank of an economy. It deals with the demand and supply of money.
Fiscal policy refers to the use of taxation and public expenditure by the government to stabilise the economy.
A monetary policy aims at achieving full employment. Unemployment leads to wastage of potential and resources. Price stability is another goal of monetary policy. Changes in price levels lead to uncertainty in the economy. Achieving economic growth and maintaining a favourable balance of payments are some of the objectives of this policy.
A fiscal policy aims at achieving full employment, stabilizing the price levels and growth rate of the economy, maintaining equilibrium in the balance of payments. It uses taxation to affect national income, output, prices etc.
Monetary policy uses various instruments to achieve it’s goals. Open market operations, bank rate policy, selective credit controls, changes in reserve ratios are some of the instruments of monetary policy. Open Market Operations refers to sale and purchase of securities in money market by the central bank. Bank rate is the minimum lending rate of the central bank. When there is rise in prices, the central bank raises the bank rate and vice versa. Selective Credit Controls are used to influence specific types of credit for specific purposes.
A monetary policy can be classified as an expansionary or a contractionary policy. In the former case, monetary policy is used to overcome a recession or deflationary gap. It generally happens when there is a reduction in demand for consumer goods or investment goods. To control this central bank starts an expansionary monetary policy that reduces credit market conditions and leads to upward shift in demand. In the later case, monetary policy is used to curtail aggregate demand. When the economy faces inflationary gap due to rise in demand for consumer goods and increase in business investment, the central bank increases the cost of bank credit. This is often done by selling government securities, rising discount rate etc.
Similarly, fiscal policy can be classified as neutral, expansionary and contractionary. Neutral policy is usually undertaken when an economy is in equilibrium. In this instance, government spending is fully funded by tax revenue, which has a neutral effect on the level of economic activity. Expansionary policy is usually undertaken during recessions to increase the level of economic activity. In this instance, the government spends more money than it collects in taxes. Contractionary type of policy is undertaken to pay down government debt and to cap inflation. In this case, government spending is lower than tax revenue.
Monetary and Fiscal policy both have their own advantages and disadvantages. Fiscal policy may sometimes result in a domino effect causing one problem to make another and repeat. Fiscal policy can also have issues with time lags. Although monetary policy is not very effective in a recession, it is flexible and works well to slow down the economy. Most people however, prefer fiscal over monetary because its brings low taxes and low interest rates.