Fiscal policy vs monetary policy: the U.S. difference

In the United States, fiscal policy is the federal government’s approach to taxes and spending, determined by Congress and the administration. Monetary policy consists of Federal Reserve actions to pursue maximum employment and price stability, including actions that influence interest rates and the money supply.

The policies are made by different institutions and use different levers. Fiscal choices can affect gross domestic product growth, employment and inflation, factors the Federal Open Market Committee considers when setting the stance of monetary policy.

Fiscal policy and monetary policy, compared

• Fiscal policy: Congress and the administration determine federal tax and spending policies.
• Monetary policy: The Federal Reserve determines the stance of monetary policy. The FOMC reviews economic and financial developments when making that assessment.
• Fiscal-policy measures: Government revenue collection and spending. The budget deficit is the difference between government spending and revenue.
• Monetary-policy tools: Open market operations, the discount rate, reserve requirements and interest on reserve balances.

How the mechanisms differ

Fiscal policy works through the government’s taxing and spending decisions. Those decisions determine revenue collection and public outlays.

Monetary policy works through central-bank tools affecting money and interest rates. In open market operations, the Fed can buy government securities. According to the St. Louis Fed, purchases increase the reserve funds banks have available to lend and put downward pressure on the federal funds rate.

Congress established maximum employment and price stability as the Fed’s macroeconomic objectives. It also specified that operational monetary-policy decisions should be free from political influence; the Fed is an independent agency of the federal government.

Interaction without shared control

The Fed does not determine fiscal policy. However, the FOMC considers current and projected fiscal-policy paths because they may affect GDP growth, employment and inflation. Fiscal policy therefore influences monetary-policy deliberations indirectly through the economic outlook.

That relationship does not change the division of authority: Congress and the administration retain responsibility for taxes and spending, while the Fed determines monetary policy.

A U.S. example: the 2007–09 financial crisis

During the financial crisis and subsequent Great Recession, the Fed provided short-term liquidity and bought large quantities of U.S. Treasury and mortgage-backed securities. The St. Louis Fed says those purchases were intended to put downward pressure on longer-term interest rates and ease overall financial conditions.

Federal executive and legislative authorities also enacted programs, including the Economic Stimulus Act, the Housing and Economic Recovery Act and the Emergency Economic Stabilization Act. The St. Louis Fed describes those measures as intended to inject funds into the economy and stimulate business and consumer spending.

Sources

• The Fed - What is the difference between monetary policy and fiscal ... — www.federalreserve.gov
• The Difference between Fiscal and Monetary Policy | St. Louis Fed — www.stlouisfed.org