Monetary policy is run by the central bank through money supply and interest rates; fiscal policy by the government through taxes and spending. The key differences side by side.
Monetary policy and fiscal policy are two different tools that have an impact on the economic activity of a country.
Monetary policies are formed and managed by the central banks of a country and such a policy is concerned with the management of money supply and interest rates in an economy.
Fiscal policy is related to the way a government is managing the aspects of spending and taxation. It is the government’s way of stabilizing the economy and helping in the growth of the economy.
Governments can modify the fiscal policy by bringing in measures and changes in tax rates to control the fiscal deficit of the economy.
The main differences between monetary and fiscal policy are set out below.
| Monetary Policy | Fiscal Policy |
|---|---|
| Definition | |
| It is a financial tool that is used by the central banks in regulating the flow of money and the interest rates in an economy | It is a financial tool that is used by the central government in managing tax revenues and policies related to expenditure for the benefit of the economy |
| Managed By | |
| Central Bank of an economy | Ministry of Finance of an economy |
| Measures | |
| It measures the interest rates applicable for lending money in the economy | It measures the capital expenditure and taxes of an economy |
| Focus Area | |
| Stability of an economy | Growth of an economy |
| Impact on Exchange rates | |
| Exchange rates improve when there is higher interest rates | Its effect on exchange rates is indirect |
| Targets | |
| Monetary policy targets inflation in an economy | Fiscal policy has no single target like inflation; it works towards growth within fiscal deficit limits |
| Impact | |
| Monetary policy has an impact on the borrowing in an economy | Fiscal policy has an impact on the budget deficit |
Fiscal Deficit refers to the gap between the government’s total expenditure in a given financial year and its total revenue (excluding borrowings) in the same financial year. It is expressed as a percentage of the Gross Domestic Product (GDP) and is an indicator of the government’s financial health.
The primary objectives of monetary policies are the management of inflation or unemployment and maintenance of currency exchange rates.
1. Inflation
Monetary policies can target inflation levels. A low level of inflation is considered to be healthy for the economy. If inflation is high, a contractionary policy can address this issue.
2. Unemployment
Monetary policies can influence the level of unemployment in the economy. For example, an expansionary monetary policy generally decreases unemployment because the higher money supply stimulates business activities that lead to the expansion of the job market.
3. Currency exchange rates
Using its monetary authority, a central bank can influence the exchange rates between domestic and foreign currencies. For example, the central bank may increase the money supply by issuing more currency. In such a case, the domestic currency becomes cheaper relative to its foreign counterparts.