Difference between Fiscal Stimulus and Monetary Stimulus | Worry after the financial crisis is nothing new. When financial markets fall, it has a significant impact on the economy. During times of economic crisis, the operations of financial institutions are often reshaped – for example, the panic of 1907 led to the creation of the Federal Reserve System or United States banking regulation after the bank failures during the Great Depression in the early 1930s.
An economic slowdown is defined as a period requiring a negative growth rate or when the standard deviation falls below zero. During periods of economic slowdown, governments and central banks can try to kickstart the economy by using the two main tools at their disposal, namely fiscal stimulus and monetary stimulus.
Before we dive into the discussion of the difference between fiscal stimulus and monetary stimulus, it helps us understand what a fiscal stimulus is and what a monetary stimulus is.
Definition of Fiscal Stimulus
Fiscal Stimulus is a legitimate tool used by the government to deal with the decline in economic performance. The economy does not always show its potential. When actual output falls below its potential, a certain situation arises which economists call a recession gap.
Factories went out of business and workers became unemployed. Sometimes, actual output briefly rises above its potential. This is what economists call the inflation gap. Workers work around the clock and unemployment is inevitable, which is not sustainable. The real life implications are not as predictable as they seem. To deal with the downturn, policymakers must step in to reduce inflation.
Also read: The Difference Between Inflation and Recession
One way is through fiscal policy. The idea of a simple fiscal stimulus; when the economy falls, the government can step in by changing government spending or taxes to revive the economy. This increases output and income in the short term which in turn increases the demand for goods and services, which in turn reduces the burden of the recession and boosts growth.
Definition of Monetary Stimulus
Monetary stimulus is basically the way the central bank manages the money supply in a country’s economy. That is, the government tries to regulate the amount of money in circulation by increasing the amount of money in the nation’s economy and lowering the cost to access it.
So, the central bank creates money but doesn’t actually print it. This increases the amount of money he has electronically. Usually, this can be achieved in one of two ways. The first way is to lower market interest rates which will encourage businesses to invest as loans become cheaper, which in turn helps boost the economy.
The next thing is the money supply; what they can do is increase the money supply simply by injecting extra money into the economy.
Both fiscal and monetary stimulus policies are necessary measures to attract global capital inflows during economic downturn and recovery. They affect wages, employment, inflation, interest rates, and exchange rates, but their policy implications differ fundamentally.
In the Keynesian paradigm, monetary policy is an effective tool for macroeconomic stabilization aimed at achieving higher GDP growth and promoting full employment. Fiscal stimulus serves to adjust the level of government spending and tax rates to affect the economy.
This will increase output and income in the short term which in turn increases the demand for goods and services, which in turn reduces the burden of the recession.