Monetary Policy vs Fiscal Policy
Monetary Policy
Designed and implemented by the State
Bank or Central Bank.
Deals with levels of money supply in the
economy.
Effects economic conditions and inflation
through amount of money in circulation.
Effects exchange rate.
Fiscal Policy
Designed and implemented by the
Ministry of Finance.
Deals with how much to spend and where
to spend in the economy.
Effects economic conditions and inflation
through government induced activity.
Does not directly effect exchange rate.
 Monetary Policy Tools
• Reserve Ratio Requirement – Percentage of
total deposits that commercial banks can
forward as loans.
• Policy Rate/Discount Rate – Rate at which
central bank provides loans to commercial
banks
• Open Market Operations – buying and selling of
govt. securities by central bank to control
money supply. Usually a short term tool
 Reserve Ratio Requirement
Increase Decrease
Money available for providing loans goes Money available for providing loans goes
down. up.
Interest rates go up thus increasing cost of Interest rates go down thus reducing cost
loans. of loans.
Companies reduce expansion due to Companies engage in expansion due to
costly loans cheaper loans
Economy contracts Economy expands
Inflation goes down Inflation goes up
 Policy Rate/Discount Rate
Increase Decrease
Interest rates go up thus increasing cost of Interest rates go down thus reducing cost
loans. of loans.
This reduces amount of loans borrowed in This increases amount of loans borrowed
the economy thus reducing money supply. in the economy thus increasing money
supply.
Companies reduce expansion due to Companies engage in expansion due to
costly loans. cheaper loans.
Economy contracts. Economy expands.
Inflation goes down. Inflation goes up.
 Open Market Operations
Central Bank Sells Securities
Securities are sold to commercial banks in
exchange for cash.
Cash gets transferred from commercial
banks to central bank and thus gets taken
out of economy.
Reduces money supply in short term
Interest rates go up thus increasing cost of
short term loans.
This reduces amount of short term loans
borrowed in the economy thus reducing
money supply
Liquidity decreases thus reducing activity
Economy contracts (Long term effect
after some persistence)
Inflation goes down (Long term effect
after some persistence)
Central Bank Buys Securities
Securities are bought from commercial
banks in exchange for cash.
Cash gets transferred from central bank to
commercial banks and thus gets injected
into the economy.
Increases money supply in short term
Interest rates go down thus reducing cost
of short term loans.
This increases amount of short term loans
borrowed in the economy thus increasing
money supply
Liquidity increases thus increasing activity
Economy expands (Long term effect after
some persistence)
Inflation goes up (Long term effect after
some persistence)