Fiscal policy and monetary policy are two of the most important financial planning tools that the federal government has at its disposal.
The main aim of one of these tools is to manage revenue, expenditure, and budgeting, while the other one is concerned with determining the value and cost of money. These tools also affect the processes through which economic change happens.
Cost of Money
In order to determine monetary policy, the Federal Reserve simply announces it’ll loan banks money based on a pre-determined target rate. This is known as the “federal funds” rate and it helps to determine the interest rate on credit cards, car loans and mortgages to name but a few.
A higher interest rate usually means that it’s harder for people to borrow money, leading to a sluggish flow of money, hindering economic growth, decreasing investor confidence and inflation.
Increased rates also mean heightened currency value for a country that reflects well on foreign exchange markets. But, it’s never good news for local residents who have to deal with expensive prices on goods.
How Does It Work?
The process of transforming monetary policy is quite straightforward. The Federal Reserve determines a new federal fund rate target at one of the frequent Federal Open Market Committee meetings it holds.
The Federal Reserve may also buy government bonds in order to increase their value and reduce interest rates. A board of governors votes on the target rate but this doesn’t mean that the executive branch or the legislators have any control over this policy.
However, the government does have direct control of other Federal Reserve processes, such as the appointment of the chairperson, which is typically done by the president. But, even then, the U.S. Senate has to approve the selection.
Fiscal policy is all about the decisions that the Federal Government makes regarding spending, budgets, and taxes.
Legislators are always looking for ways to raise and spend money more wisely, both at a federal and state level. However, each state has different priorities based on its needs, and the sentiments of political factions and parties must be taken into account as well.
Before a policy can pass, legislators must gain voter support and base their decision on public sentiment. This is why it’s much more difficult to change fiscal policy when compared to monetary policy because there are lots of different moving pieces and hoops to jump through.
Fiscal policy and monetary policy are both essential tools for a country’s economic success. They affect important indicators such as price stability, employment (or lack thereof) and inflation.
The bad news is there’s no catch-all panacea with either tool because each comes with its own advantages and disadvantages that cannot be avoided.
However, when used effectively, both fiscal policy and monetary policy can yield incredible benefits for a country’s economy, especially when it comes to stimulating demand after a major crisis.