Fiscal policy involves government control over an economy through taxation and spending, while monetary policy involves credit availability and cost. Political and economic views influence government spending decisions, which can be financed through taxation, borrowing, reserves, or asset sales. Fiscal policy can be used with monetary policy to manage inflation, and some governments delegate monetary policy to an independent authority.
Fiscal policy is one of the two main types of control that a government or its agencies can exercise over an economy. The main instruments of fiscal policy are taxation and spending; on the contrary, monetary policy involves the availability and cost of money, or more specifically, credit. Fiscal policy instruments can achieve, or at least attempt to achieve, both economic and political goals. All fiscal policy tools ultimately serve to answer two questions: how much a government should spend and how it should finance this spending.
The decision on how much to spend can depend on both political and economic points of view. As a very gross simplification, right-wing governments tend to believe in cutting government spending and letting more elements of the economy be determined by free markets. Left-wing governments, on the other hand, tend to believe in more public spending, often for social purposes. It’s important to remember that terms like left wing and right wing are often relative terms. In many cases the positions taken by the main left and right parties in one country may appear relatively close to another country’s politics and economy.
In most cases, government spending is financed largely by taxation. This is another example of how fiscal policy instruments can have a social or political purpose as well as an economic objective. In addition to simply deciding how much taxes should be raised overall, a government can use taxes as a form of redistribution, taxing the wealthiest people to finance welfare payments. It can also use taxes to encourage or discourage social behavior, such as heavily taxing tobacco to try to reduce smoking levels.
There are other ways to raise money for groceries. These include borrowing money, using an existing reserve accumulated in the past, and selling government-owned assets. Over time, these methods can create a government deficit and thus a growing debt. This can affect the decisions governments make about fiscal policy tools: for example, a political party that believes strongly in tax-financed high spending may decide that it needs to spend less than it generates in order to reduce a deficit.
Fiscal policy tools can be used in conjunction with monetary policy tools. These include setting base rates which, in most economies, have a knock-on effect on the rates banks charge for lending to the public or businesses. Usually, the goal of such policies is to manage the level of inflation, as the theory is that higher rates mean people spend more on repaying mortgages and other loans and therefore have less to spend on goods. While some governments use fiscal and monetary policy together, others make monetary policy the responsibility of an independent monetary authority, such as a national bank.
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