Economy News

Explained: How is monetary policy different from fiscal policy

One key distinction between monetary and fiscal policy lies in their implementation authorities and tools.

Monetary policy and fiscal policy serve as critical tools for managing the country’s economy, each with distinct objectives and mechanisms. Understanding the differences between these policies is essential for comprehending how economic decisions are made and their impact on various sectors.

What is monetary policy?

Monetary policy, formulated and implemented by the Reserve Bank of India (RBI), primarily focuses on regulating the money supply, interest rates, and inflation levels. The RBI employs tools such as the repo rate and open market operations to influence liquidity in the financial system and control borrowing costs.

The repo rate is the rate at which the RBI lends money to commercial banks, influencing borrowing costs and liquidity in the economy. Open market operations involve buying and selling government securities to regulate the money supply and interest rates.

For instance, in response to rising inflation, the RBI may choose to increase the repo rate, thereby making borrowing more expensive and curbing excessive spending. Conversely, during periods of economic slowdown, the RBI may lower interest rates to encourage borrowing and stimulate investment.

What is fiscal policy?

On the other hand, fiscal policy pertains to government decisions concerning taxation, government spending, and budgetary allocations. The government employs fiscal policy to manage aggregate demand, promote growth, and address socioeconomic challenges. For example, during the Covid-19 pandemic, the Indian government implemented steps such as higher spending on healthcare, infrastructure and social welfare programs. Additionally, tax cuts and stimulus packages were introduced to boost consumer spending and that in turn generated money to help revive economic activity.

Key distinction between monetary and fiscal policy

One key distinction between monetary and fiscal policy lies in their implementation authorities and tools. Monetary policy is solely under the jurisdiction of the RBI, an independent central bank mandated with maintaining price stability and fostering economic growth. In contrast, fiscal policy decisions are made by the government, with the Ministry of Finance playing a central role in formulating budgets, tax policies, and expenditure plans.

Furthermore, monetary policy tends to have a more immediate impact on financial markets and borrowing costs, influencing investment and consumption behaviour. In contrast, fiscal policy measures, such as infrastructure spending or tax reforms, can have broader and longer-term implications for economic growth and development.

Fiscal and monetary policy tools

In India, fiscal policy tools include taxation policies, government spending, and budgetary allocations. Taxation policies involve setting tax rates, exemptions, and incentives to influence consumer behaviour and government revenue. Government spending refers to investments in infrastructure, healthcare, education, and social welfare programs. Budgetary allocations determine the distribution of funds across different sectors and programs.

Monetary policy tools in India are controlled by the Reserve Bank of India (RBI) and include the repo rate and open market operations.

In summary, the coordination and alignment of monetary and fiscal policies are essential for achieving macroeconomic stability and sustainable growth in India. While monetary policy focuses on managing liquidity and interest rates, fiscal policy addresses broader economic challenges through taxation and spending decisions, ultimately shaping the country’s economic trajectory.

Leave a Reply

Your email address will not be published. Required fields are marked *