 Ask
Dr. Econ
What is the difference between fiscal and monetary
policy? (03/2002)
Monetary policy is typically implemented by a central
bank, while fiscal policy decisions are set by the national government.
However, both monetary and fiscal policy may be used to influence the
performance of the economy in the short run.
Basics
In general, a stimulative monetary policy is expected
to improve the economy's rate of growth of output (measured by Gross Domestic
Product or GDP) in the quarters ahead; tight or restrictive monetary policy
is designed to slow the economy in the future to offset inflationary pressures.
Likewise, stimulative fiscal policies, tax cuts, and spending increases
are normally expected to stimulate economic growth in the short run, while
tax increases and spending cuts tend to slow the rate of future economic
expansion.
In 2001 the Federal Reserve made 11 reductions in
the overnight interbank interest rate or federal funds rate—these actions
were designed to stimulate growth in the face of a slowing economy.
In contrast, in 1999 and 2000 when the economy was experiencing very rapid
growth and a potentially unsustainable expansion without an increase in
the rate of inflation, the Federal Reserve raised the federal funds rates
in an effort to slow the overheated economy. (See Chart 1.)
Chart 1
Fiscal policy in 2001 also helped stimulate the slowing
economy with a combination of tax cuts and spending increases. Spending
increases take effect relatively quickly, while tax cuts may take several
quarters to affect overall spending and output. (See Chart 2.)
Chart 2
Monetary Policy
Monetary policy's impact on the economy is described
in the Federal Reserve System's Purposes
and Functions publication.
The Federal Reserve Act lays out the goals of
monetary policy. It specifies that, in conducting monetary policy,
the Federal Reserve System and the Federal Open Market Committee should
seek "to promote effectively the goals of maximum employment,
stable prices, and moderate long-term interest rates."
Using the tools of monetary policy, the Federal
Reserve can affect the volume of money and credit and their price-interest
rates. In this way, it influences employment, output, and the general
level of prices.
The Federal Open Market Committee (FOMC), the Fed's
monetary policy-making body, issues a statement following each of its
eight annual meetings. The statements describe economic conditions, monetary
policy, and the actions the FOMC took with respect to the federal funds
rate and the discount rate—the rate the Fed charges depository institutions
for overnight borrowing . Those statements may be viewed on the Federal
Reserve Board's website.
For a general introduction to monetary policy issues,
let me recommend the Federal Reserve Bank of San Francisco's publication,
U.S. Monetary
Policy, an Introduction.
Fiscal policy
Samuelson and Nordhaus, in their text Economics
(1998), define fiscal policy as follows:
A government's program with respect to (1) the
purchase of goods and services and spending on transfer payments,
and (2) the amount and type of taxes.
Over the past year the U.S. budget has shifted from
a surplus to a deficit, in part as a result of changes in fiscal policy.
A combination of tax reductions, increased spending, and the 2001 recession
caused the shift. The tax cuts and increased spending are part of the
government's fiscal policy that is designed to increase short-run economic
growth. For an update on the state of the U.S. budget in 2002, please
review the FRB SF Economic Letter by Carl E. Walsh titled,
"The
Changing Budget Picture."
In addition, the Congressional Budget Office prepares
a "Monthly
Budget Review" that evaluates current
tax receipts and spending outlays and compares estimated and actual budget
figures.
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