Difference between monetary and fiscal policy Essay Example Pdf

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Describe the difference between monetary and fiscal policy in the UK and explain how such policies can be used to achieve different macroeconomic government objectives.

The main and most obvious difference between monetary and fiscal policy is that monetary policy is set by the central bank and fiscal policy is implemented by the government. In the case of the UK, monetary policy is decided upon by the Bank of England which since 1997 has been independent from the government. It would be worth considering the two types of economic policy in more detail now before turning to look at how they can be used to help meet macroeconomic government objectives. Monetary policy is the attempt to control macroeconomic variables through the setting of interest rates. It is a rather blunt policy tool as its effects can be felt throughout the economy as a whole. By changing interest rates, the Bank of England is trying to influence the overall expenditure in the economy as well as controlling inflation. Reducing interest rates makes borrowing the more attractive alternative to saving which then leads to more spending in the economy. Lowering interest rates can also make assets such as property increase in value which also leads to more spending as homeowners extend mortgages and consume more. By cutting interest rates, it is hoped that this increased spending feeds through to output and then to employment. Increasing interest rates on the other hand, has the opposite effect by making saving more attractive than spending and therefore overall spending in the economy is reduced. Fiscal policy is controlled by central government. It can be defined as, “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 tax” (Samuelson and Nordhaus, 1998). It involved the government changing levels of taxation and spending in order to influence the level of aggregate demand (AD). The purpose of fiscal policy is to reduce inflation, stimulate economic growth and to stabilise this growth and avoid periods of ‘boom and bust’ which characterised the economy during the 1980s and early 1990s. If monetary policy is described as a blunt instrument then fiscal policy is a precision tool that can target particular sectors of the economy and population in order to achieve the desired economic changes. Both these different types of policy are working towards achieving different macroeconomic objectives. It would be worth looking at these in greater detail now. There are four major macroeconomic objectives that any economic policy should be working to achieve. These are full employment; price stability; sustainable economic growth and; keeping the Balance of Payments in equilibrium. These four different objectives compete with each other and all achieve different levels of importance depending on the priorities of the government. During the 1960s, the Balance of Payments took centre stage. This was before the global economy made operating with a deficit a viable and sustainable option. Nowadays most governments operate with a budget deficit and the balance of Payments is no longer seen as a top priority for the government.

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