What is the Difference Between Fiscal and Monetary? And Why Should I Care?

In the news, we have been hearing a lot about fiscal policy and monetary policy. It’s been said by many that the problem is that the US can’t get its “fiscal house” in order.

Others say that the Federal Reserve’s “monetary policy” is hurting rather than helping the economy.

So, how are they different?

The term fiscal refers to revenue and spending. Basically, when you see that in the news, you will usually see Congress associated with it.  In local news, you will see city councils or state legislatures mentioned.  In all three levels (national, state and local), the power to spend is always given to the houses (or House, in the case of Nebraska).

The reason for this is that the founding fathers, with their fear of having a president that was too powerful, gave the right to tax and spend to Congress.  This way, whatever the President might want to do, only Congress could give him the money to do it.

So, when you read about anything “fiscal”, think of taxes and spending.  The President and Congress will have arguments over it.

To frame it in today’s context, the big argument overall is the use of tax money (fiscal policy) during a weak economy. Republicans do not believe any tax money should be spent to create jobs; no stimulus.  Democrats believe the government is obligated to spend tax money to create jobs.

What difference does it make to you? This is a question of personal belief.  Do you believe the government should spend money to create jobs during hard times? Or do you think businesses will hire people and the government should stay out of it?

Monetary, on the other hand, refers to the supply of money in circulation.  The chart above gives an idea of what that looks like.

Based on the law of supply and demand, the more scarce a thing is, the more expensive it becomes.  The Federal Reserve has the power to regulate the amount of money in circulation in the United States.  If the Fed thinks there is too much money in circulation, it can do a couple of things: raise interest rates or sell Treasury Bills.

Raising interest rates makes it harder for people and companies to get credit.  When that happens, people slow down their buying and companies slow down their production. In effect, there is less money in circulation so it is more expensive to borrow.

Lowering interest rates has the opposite effect: people spend more and companies tend to increase production because, well, people are buying more.  There is more money in circulation so it is cheap to borrow.

What difference does it make to me? Monetary policy affects things like your credit card interest rates or your car or home loan if you have an adjustable rate mortgage.

Monetary policy is also used to stem inflation.  If prices start getting higher, it means there is too much money around so it isn’t worth as much, say, television set.  The Fed will usually raise interest rates to make it harder to get money.  Also, at higher interest rates, investors will buy more Treasury Bills which also takes money out of circulation and locks them up for different periods of time.

If I got something wrong or you have any questions, post a comment with it.