What is the difference between monetary policy and fiscal policy?

by Manshu on February 1, 2013

in Economy

Couple of days ago I wrote a post answering some questions about monetary policy, and in this post I’m going to write about the difference between fiscal policy and monetary policy as these are two terms which are used together quite often.

Both of these are used to influence the economy of a country, but while the monetary policy is decided by the central bank or RBI in India’s case, the fiscal policy is decided by the government.

Monetary Policy

Monetary policy is carried out by RBI and manifests itself by setting interest rates like the Repo and Reverse Repo as well as determining levels of CRR and SLR which influence money supply and credit flow in the economy.

The main aim of RBI’s monetary policy is to keep a check on inflation and maintain an optimum level of GDP growth at the same time. If they raise the interest rates too high then that might help in checking inflation but at the same time deter economic activity and slow down GDP growth, and if they keep the rates too low then that will promote economic activity but it will also spur inflation.

They have to keep a balance between both so one is not sacrificed for the sake of the other.

The RBI is independent from the government and you can see this in the fact that RBI has been very slow to lower rates even when a lot of government officials have publicly said that rates should come down in the past couple of years or so.

Difference between Fiscal Policy and Monetary Policy

Fiscal Policy

Fiscal policy is the policy that determines how the government spends money, and taxes people to pay for those expenses. Taxes are the main form of earnings for the government although there are other forms as well like 3G auctions or PSU disinvestments. When the government is not able to come up with enough earnings to pay for their expenses they incur a fiscal deficit (Read: What is the meaning of fiscal deficit?), and this deficit is financed by borrowings.

The purpose of the fiscal policy is to promote economic growth as well, and during times of recession when government increases its spending or cuts taxes – that’s termed as a fiscal stimulus package because you are using the instruments of fiscal policy to boost the economy. India has had three fiscal stimulus packages following the last recession which involved tax cuts and boosts in spending, and were similar to stimulus measures used by countries around the world.

Conclusion

The goals of the monetary policy and fiscal policy are the same which is to promote stable and growing economic conditions in an economy, but the instruments used to carry these out and the bodies that carry these out are different.

They should be in synch to work well and such that actions of one don’t scuttle the actions of another and they succeed in their goals of maintaining a reasonable level of inflation and steady economic growth.

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