Comparison of monetary and fiscal policies
fiscal and monetary policy - comparison
Introduction
Fiscal policy should not be seen is isolation from monetary policy.
For most of the last thirty years, the operation of fiscal and monetary policy was in the hands of just one person – the Chancellor of the Exchequer. However the degree of coordination the two policies often left a lot to be desired. Even though the BoE has operational independence that allows it to set interest rates, the decisions of the Monetary Policy Committee are taken in full knowledge of the Government’s fiscal policy stance. Indeed the Treasury has a non-voting representative at MPC meetings. The government lets the MPC know of fiscal policy decisions that will appear in the annual budget.
Impact on the Composition of Output
Monetary policy is seen as something of a blunt policy instrument – affecting all sectors of the economy although in different ways and with a variable impact
Fiscal policy changes can be targeted to affect certain groups (e.g. increases in means-tested benefits for low income households, reductions in the rate of corporation tax for small-medium sized enterprises, investment allowances for businesses in certain regions)
Consider too the effects of using either monetary or fiscal policy to achieve a given increase in national income because actual GDP lies below potential GDP (i.e. there is a negative output gap)
Monetary policy expansion
Lower interest rates will lead to an increase in both consumer and fixed capital spending both of which increases current equilibrium national income. Since investment spending results in a larger capital stock, then incomes in the future will also be higher through the impact on LRAS.
Fiscal policy expansion
An expansion in fiscal policy (i.e. an increase in government spending) adds directly to AD but if financed by higher government borrowing, this may result in higher interest rates and lower investment. The net result (by adjusting the
Introduction
Fiscal policy should not be seen is isolation from monetary policy.
For most of the last thirty years, the operation of fiscal and monetary policy was in the hands of just one person – the Chancellor of the Exchequer. However the degree of coordination the two policies often left a lot to be desired. Even though the BoE has operational independence that allows it to set interest rates, the decisions of the Monetary Policy Committee are taken in full knowledge of the Government’s fiscal policy stance. Indeed the Treasury has a non-voting representative at MPC meetings. The government lets the MPC know of fiscal policy decisions that will appear in the annual budget.
Impact on the Composition of Output
Monetary policy is seen as something of a blunt policy instrument – affecting all sectors of the economy although in different ways and with a variable impact
Fiscal policy changes can be targeted to affect certain groups (e.g. increases in means-tested benefits for low income households, reductions in the rate of corporation tax for small-medium sized enterprises, investment allowances for businesses in certain regions)
Consider too the effects of using either monetary or fiscal policy to achieve a given increase in national income because actual GDP lies below potential GDP (i.e. there is a negative output gap)
Monetary policy expansion
Lower interest rates will lead to an increase in both consumer and fixed capital spending both of which increases current equilibrium national income. Since investment spending results in a larger capital stock, then incomes in the future will also be higher through the impact on LRAS.
Fiscal policy expansion
An expansion in fiscal policy (i.e. an increase in government spending) adds directly to AD but if financed by higher government borrowing, this may result in higher interest rates and lower investment. The net result (by adjusting the