The difference between fiscal and monetary policy

It can be tricky to distinguish between fiscal and monetary policy.

Let’s try and make it a bit easier.

Fiscal policy is all about the federal government’s use of the federal budget. It’s about the government changing government spending (an injection, the symbol is G) and taxation revenue (a leakage, the symbol is T) to affect the level of economic activity…and achieve other economic objectives.

Fiscal policy is budget policy.

Monetary policy is different.

Monetary policy involves the Reserve Bank of Australia’s (RBA) actions to alter the value of the cash rate to control the level of inflation (and affect economic growth). The RBA changes the cash rate to create changes in the general level of interest rates (set by the commercial banks) to deal with inflation and growth and employment and other challenges.

Big thing to note: monetary policy is government policy. But the government does not implement monetary policy.

Monetary policy is implemented by the independent RBA, on behalf of the government.

Fiscal policy: think about the budget.

Monetary policy: think about interest rates and the RBA.

Hope this helps. Try this video too.

Understanding automatic stabilisers

This is a tough one. But, rather than explain it to you with words, I’m going to explain it to you with pictures.

This video about automatic stabilisers is one of the first Eco videos I created. Audio’s not great, but stay tuned for the hilarity.

Once you’ve seen the videos, answer the questions in the sheets. Super helpful for consolidating your knowledge about this weird concept.

Questions in the comments pls.

Why are Australia’s macroeconomic policies fighting?

At 2:30pm today, the Reserve Bank of Australia kept the cash rate on hold at 1.5 per cent. Economists weren’t sure what the RBA would do: would it cut rates further? Would it keep them steady? . So the decision surprised some. But this isn’t the most interesting thing.

What I find most interesting is the conflict between Australia’s macroeconomic policies.

[See my instant reaction video about the RBA’s decision.]

As a quick refresher, macroeconomic policies are policies that affect the whole economy, not just one sector. The major macro policies are monetary policy (the RBA’s influencing the general level of interest rates in the economy) and fiscal policy (the use of the Federal Budget).

These macro policies can be used to speed up or slow down the economy. In terms of achieving goals, it’s helpful if they’re working in the same direction and not against each other.

But check this out. Monetary policy is wildly expansionary. It is at historic lows, in an attempt to increase Australia’s pretty average economic growth rates. At the same time, fiscal policy is contractionary. That is, the government is trying to create a budget surplus (a situation where government revenue, a leakage, exceeds government spending, an injection).

Put simply: monetary policy is trying to expand the economy, fiscal policy is actually working to slow it down.

Why are they working in opposite directions? Part of it is the federal government’s attempts to quickly return the nation’s budget back to surplus. The RBA is independent of government, so it’s pursuing a different plan.

It gets even more complicated, though. The federal government is planning to run a budget surplus...but it is planning to implement major tax cuts (an injection) if it wins the upcoming election. So, even within fiscal policy, the government is trying to achieve competing goals.

AS A STUDENT, HOW CAN I USE THIS INFORMATION?

• When you’re writing about Australia’s use of macroeconomic policies, discuss the conflicts between the policies themselves

• You can also discuss conflicts WITHIN fiscal policy, where different measures are working to slow and expand the economy simultaneously

• Make sure to mention that fiscal policy is controlled by the federal government, while the independent RBA handles monetary policy