Fiscal vs Monetary Policy

See Also:

Generally Accepted Accounting Principles (GAAP)

Economic Drivers to Watch

 

Fiscal vs Monetary Policy

What is Fiscal Policy?

Fiscal policy is essentially how the government decides to collect and spend money to impact the economy. This is studied in Macroeconomics to better understand the relationship between the economy and governmental influence. The study of fiscal policy is useful in speculating the reaction to changes in the government’s budget. It is also a frequent topic during presidential elections, because fiscal policy affects numerous industries.

For businesses, fiscal policy can be very important. Some businesses are directly impacted by government interaction in the economy. For example, businesses that have government agencies as their clients depend upon a fiscal policy that includes their services. Furthermore, other businesses are impacted by fluctuating taxes. Some industries are more exposed than others to taxes, so it is very important that the leadership of businesses takes these maco-elements into consideration.

Expansionary Fiscal Policy

There are three phases of fiscal policy that the government switches between depending on the outlook of the economy. Expansionary fiscal policy is the term used when the government is spending more than it is receiving. This is generally thought to stimulate the economy during a recession or downturn. High government spending with no rise in taxes is common at the onset of a recession, followed by increased taxes and decreased spending. If this phase of fiscal policy does not work, it can leave the government in a greater deficit without a recovered economy.

Contractionary Fiscal Policy

Contractionary fiscal policy is the opposite of expansionary. Contractionary policy involves spending less than the government collects in taxes. Rather than attempting to stimulate the economy, this phase is meant to restrain the economy. This includes controlling inflation and paying down debt. Another tool of contractionary fiscal policy is raising taxes. When taxes are raised, households have less disposable income, and the government has more to spend.

The phase between expansionary and contractionary fiscal policies is known as neutral fiscal policy. This is a period of time when the government’s spending is approximately the same as its collections. This phase is often a transition period between expansionary and contractionary policies, so it is a time of speculation and uncertain governmental policies.

What is Monetary Policy?

Monetary policy is a term used to describe the decisions over a nation’s money supply. In the United States, the Federal Reserve has this duty. The key decisions affecting monetary policy are setting interest rates, setting bank reserve requirements, and buying/selling government securities. Thus, monetary policy is not controlled by the same agency as fiscal policy.

 

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