The Bottom Line: Monetary verus fiscal policy: How are they different?

By Reubin Turner
City Editor

This week, President Barack Obama sent a budget to Congress for the 2016 fiscal year. In this budget were several initiatives to increase both taxes for the wealthy and tax breaks for the middle and lower-income classes. Whether or not the Republican-controlled Congress will approve of this budget is yet to be seen. Some GOP lawmakers, according to the Wall Street Journal, have even expressed interest in bargaining with the president in an effort to avoid a sequester down the road.

This budget, which could have far-reaching implications for all economic classes, is part of an extremely important component of policy that can greatly influence the economy—fiscal policy.

But what exactly do economists and political pundits mean when they differentiate between fiscal and monetary policy? And how effective are the two? Although often confused, they are certainly not interchangeable and the motives that drive the two are somewhat related, yet confined.

Monetary policy deals with efforts to control the money supply, by indirectly influencing inflation, or increases in the price level. It is the Federal Reserve that acts to control inflation through a variety of policies. Some of these policies include changing the Federal funds rate and the buying and selling of U.S. treasury stocks. In addition to helping control the money supply through inflation, the Fed also helps to monitor the unemployment level. I consider the Fed to be the chief watchdog of the national economy. An article by The Atlantic recently emphasized the importance of having an independent national bank to help control the economy through their monetary policy.

In contrast, fiscal policy deals with the allocation of government funds, which are raised primarily through taxes. When income is raised through taxes, the president proposes to Congress just how the funds should be allocated. Programs such as Medicare, Medicaid and the Supplemental Nutrition Assistance Program are all funded by taxes. How much America spends on the funding of public projects such as infrastructure can also influence the national economy. When the government commissions such projects, it pays for them through taxes, which increases national output.

This strategic allocation many times can have significant impacts upon the national economy as well. Through tax breaks and increases in spending, the government can generally increase economic output, which is critically important in times of recessions. Simply put, monetary policy deals primarily with economic conditions, while fiscal policy concentrates on putting money in the hands of the population in a more direct level.

One of the most important indicators of how effective monetary and fiscal policy is depends largely on the state of the economy. In times when the economy is experiencing a recession, fiscal and monetary can be critical to helping to jumpstart the economy. Just how much the Fed and the government should get involved is an age-old debate that still has not been settled. For now, just remember this–monetary and fiscal policy both play vital, yet different roles in the economy.