Question

What is the main differences between monetary policy and fiscal policy...


What is the main differences between monetary policy and fiscal policy

Answer

Monetary policy refers to the tool which is used by central bank in order to increase or decrease money supply in the economy.

Fiscal policy initiated by government by increasing or decreasing government spending or by doing changes in tax rate in order to influence the aggregate demand.

Both these policies are used to achieve higher economic growth and to tackle inflationary pressure in the economy.

 

 

 

Monetary policy basically leads to change in interest rate and money supply and all these changes are primarily done by the central  bank. The main aim of the monetary policy is to target the inflation rate.

The main instruments of monetary policy that are used by central bank :

Open market operations 

It refers to sale and purchase of bonds by the central bank in open market. In order in increase money supply in the economy the central bank buys bond. On other hand if central bank wants to decrease money supply in the economy in this case the central bank sells bond.

 

Bank Rate 

It is the rate at which central bank is giving loans to the commercial banks. During inflation bank rates will increase by central banks in order to limit the borrowings by commercial banks. In contrary in the case of deflation the central bank will decrease bank rate.

Cash reserve ratio 

CRR is the certain minimum cash reserve which commercials banks have to maintains with central bank as percentage of their total deposits. When CRR is increased by central banks then the credit creation by commercial banks will fall and when CRR is decreased by central banks then the credit creation by commercial banks will rise.

 

 

Fiscal policy can be used by the government in order to stabilize the economy. Primarily in fiscal policy government increases or decreases the government expenditure and doing changes in tax rate. There is no particular target set by the government to achieve.

In order to increase the demand and economic growth in the economy the government should increase the government expenditure and decrease the tax rate by doing so it will lead to higher budget deficit.

In order to decrease demand and to tighten the inflation rate the government should decrease its expenditure and increases the tax rate thereby it will leads to lower budget deficit.

In the case of recession an expansionary fiscal policy will increase government expenditure and this spending will create money in the economy and helps in creating employment.

  

 

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