iFund – Government Policy (3): Differences betweem Monetary Policy and Fiscal Policy

2019-10-04 02:35
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Both monetary and fiscal policies can achieve the economic goal, but the formulation and implementation of the two policies, the policy tools and the policy time lags are all different. Investors should keep a close eye on the economic policies of the government and the central bank, and consider the appropriate allocation of their investment portfolio.

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In recent months, the global economic figures are mostly less than ideal. The market is worrying about global economic recession and is expecting the government and central banks to implement expansionary policy to stimulate economies. In the previous articles, we have mentioned the functions and policy of monetary policy and fiscal policy respectively. In this article, we will explore the differences between the two policies.

Differences between Monetary Policy and Fiscal Policy

  1. Policy Instruments

The monetary policy is formulated and implemented by the central bank. Its ultimate economic goal is to achieve financial and price stability through controlling the liquidity money available in market and the interest rates. There are four main policy instruments for monetary policy, which are open market operations, controlling the reserve requirement ratio, controlling the interest rates, and printing banknotes. All of these four tools can control the market currency liquidity. If the economy is in a downturn, the central bank may implement an expansionary monetary policy, with an aim to stimulate the economy and increase the circulation of currencies in the market by buying government bonds in the open market, lowering the reserve requirement ratio, lowering the interest rates, and printing banknotes. Conversely, the central bank will implement a contractionary monetary policy to curb overheated markets.

The fiscal policy is formulated and implemented by the government. It aims to maintain the pace of real GDP growth in a reasonable level by controlling government spending and tax rates. There are two main policy instruments for fiscal policy, which are controlling the tax rates and adjusting the government expenditure. If the economy is in a downturn, the government may implement an expansionary fiscal policy, with an aim to increase a country’s real GDP by reducing tax rates and increasing government spending. On the contrary, the government will implement a contractionary fiscal policy to reduce a country’s real GDP in order to curb overheated markets.

  1. Policy Time Lag

In terms of policy time lag, the internal time lag of monetary policy is generally shorter than that of fiscal policy. The internal time lag refers to the time from the occurrence of the economic problem to the time of policy is formulated and the implementation is begun. The monetary policy is formulated and implemented by the central bank. Its formulation and implementation procedures are relatively shorter than that of fiscal policy. The fiscal policy is formulated and implemented by the government. The legislative process is relatively lengthy, so the internal time lag will also be longer. However, the external time lag of monetary policy is generally longer than that of fiscal policy. The external time lag refers to the time between the implementation of the policy and its target to be achieved. Monetary policy affects the economic activities of the micro-organization indirectly through controlling money supply and interest rates, while fiscal policy can affect the country’s real GDP directly. Therefore, the external time lag of monetary policy is generally longer than that of fiscal policy.

In conclusion, both monetary and fiscal policies can achieve the economic goal, but the formulation and implementation of the two policies, the policy tools and the policy time lags are all different. Investors should keep a close eye on the economic policies of the government and the central bank, and consider the appropriate allocation of their investment portfolio.

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