Monetary Policy is controlled by the country’s central bank (the RBI) and deals with managing the money supply and interest rates. Fiscal Policy is controlled by the government and deals with taxation and government spending.
Monetary Policy 🏦
Monetary Policy refers to the actions undertaken by a country’s central bank (the Reserve Bank of India for India) to control the money supply and credit conditions to achieve macroeconomic goals.
- Who controls it? The Reserve Bank of India.
- Main Goal: To maintain price stability (control inflation) while keeping in mind the objective of growth.
- Simple Analogy: Think of the RBI as the driver of a car, using the accelerator (cutting interest rates) and brakes (hiking interest rates) to keep the economy running at a smooth and stable speed.
Tools of Monetary Policy
The RBI uses several tools to influence the economy:
- Repo Rate: The interest rate at which the RBI lends money to commercial banks. This is the most powerful tool.
- Cash Reserve Ratio (CRR): The percentage of a bank’s total deposits that it must keep with the RBI as cash reserves.
- Statutory Liquidity Ratio (SLR): The percentage of a bank’s total deposits that it must maintain in the form of liquid assets like cash, gold, or government securities.
- Open Market Operations (OMO): The buying and selling of government securities by the RBI in the open market to inject or absorb liquidity.
Types of Monetary Policy
- Expansionary (or Dovish) Policy: Used to stimulate the economy during a slowdown. The RBI cuts interest rates and reduces CRR/SLR to increase the money supply and encourage borrowing and spending.
- Contractionary (or Hawkish) Policy: Used to control high inflation. The RBI increases interest rates and raises CRR/SLR to reduce the money supply and discourage spending.
Fiscal Policy 🏛️
Fiscal Policy refers to the use of government spending and taxation to influence the country’s economy.
- Who controls it? The Government of India (through the Ministry of Finance and the Union Budget).
- Main Goal: To achieve economic growth, manage government finances, and ensure equitable distribution of wealth.
- Simple Analogy: Think of the government managing its household budget. It decides how much to earn (taxes) and where to spend it (on infrastructure, welfare, defense, etc.) to keep the household running well.
Tools of Fiscal Policy
The government has two main tools:
- Taxation: The government can increase or decrease direct taxes (like income tax) and indirect taxes (like GST) to influence the spending power of individuals and businesses.
- Government Spending: The government can increase or decrease its spending on various areas like infrastructure (roads, ports), defense, subsidies, and social welfare schemes.
Types of Fiscal Policy
- Expansionary Policy: Used during a recession to boost economic activity. The government cuts taxes (leaving more money with people) and increases its spending (creating jobs and demand).
- Contractionary Policy: Used during times of high inflation. The government increases taxes (taking money out of circulation) and reduces its spending to cool down the economy.
Summary: Monetary vs. Fiscal Policy
| Feature | Monetary Policy | Fiscal Policy |
| Implemented By | Central Bank (RBI) | Government (Ministry of Finance) |
| Main Tools | Interest Rates (Repo), CRR, OMO | Taxation and Government Spending |
| Primary Focus | Price Stability (Controlling Inflation) | Economic Growth & Managing Finances |
| Impacts | Cost of borrowing, money supply | Aggregate demand, budget deficit |
| Implementation Speed | Can be implemented relatively quickly | Slower, as it often requires legislative approval (e.g., in the Budget) |