Lesson 1 of 5 · 14 min
Monetary versus fiscal policy and the roles of fiscal policy
Fiscal policy is the government using spending and taxes to manage demand, share out income and allocate resources, while monetary policy is the central bank steering money and credit; both aim for stable, positive growth with low, stable inflation.
In short
- Monetary policy: central bank actions that influence the quantity of money and credit. Fiscal policy: the government's decisions on taxation and spending.
- Shared goal: stable, positive growth with low, stable inflation, avoiding booms followed by long slumps. Only fiscal policy is also used directly to redistribute income and wealth.
- Fiscal policy affects (1) aggregate demand and output, (2) the distribution of income and wealth, (3) the allocation of resources between sectors.
- Budget balance = revenue (taxes net of transfers) minus spending (including debt interest). A rising deficit or falling surplus signals expansionary policy; the reverse signals contractionary policy.
- Automatic stabilizers (progressive taxes, unemployment benefits) move the budget countercyclically without any decision; discretionary policy is a deliberate change in spending or tax rates.
- Keynesians see strong fiscal effects when there is spare capacity; monetarists see only temporary effects and prefer monetary policy for controlling inflation.
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