When it comes to influencing economic growth in a country, the authorities are considered to have two main levers. These are monetary policy and fiscal policy.
Monetary policy is managed by central banks who aim to meet economic goals set by governments. They do this by influencing the amount of money circulating in the economy. For example, most central banks, including the Bank of England, are asked to target a specific level of inflation. This is usually around 2%. By the way, there is no specific rationale behind the 2% target; it’s just generally viewed to be roughly the “right” amount of inflation for most developed economies.
The central bank influences the cost of borrowing by raising or cutting interest rates, or printing money to buy government bonds and other assets. In theory, when it’s cheaper to borrow money and less rewarding to save, people and companies will invest and spend more. That boosts growth, which should eventually drive up inflation. If inflation gets too high, the central bank raises interest rates. That raises the cost of borrowing and encourages saving over consumption, which should slow growth and choke off inflation.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Fiscal policy, on the other hand, refers to the tools used by governments to influence the economy. Governments can raise and lower taxes. They can also direct spending at specific industries or groups of people. Fiscal policy is more targeted and arguably more powerful than monetary policy. But clearly, it is also more political. It creates winners and losers in a much more explicit manner than monetary policy.
One core feature of economic management in the late 1990s and the run-up to the 2008 financial crisis was an increasing reliance on monetary policy to smooth over ups and downs in the economy. In effect, governments delegated macro-economic management to their central banks. Nobody really complained because most economies seemed to be pottering along merrily. However, the 2008 financial crisis shattered that illusion. Since then, economic growth has been weak, while at the same time soaring asset prices have fueled a perception of growing inequality. Faith in monetary policy has been eroded.
Meanwhile, fiscal policy – such as subsidising wages – is now being used to tackle the effects of pandemic lockdowns. This is likely to last long beyond Covid, and has some serious implications for investors. To learn more about this huge political and economic shift, subscribe to MoneyWeek magazine.
-
Trouble brews in B&M as bargain shops take a hitOpinion Once a stock market darling, B&M's share price has slumped. What has gone wrong for bargain shops?
-
US and China reach a ceasefire in their trade war after talks in LondonThe US and China's trading relationship – the most important one in the global economy – is back on track. Will the truce last?
-
What is a dividend yield?Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
-
Fiscal drag could cost millions of earners thousands – what is it, and how can I protect my money?Videos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
-
What is a deficit?Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
-
Too embarrassed to ask: what is moral hazard?Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
-
Too embarrassed to ask: what is contagion?Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
-
Too embarrassed to ask: what is stagflation?Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
-
Too embarrassed to ask: what is the metaverse?Videos The term “metaverse” sounds like something out of a science fiction novel (and it is). But what does it actually mean?
-
Too embarrassed to ask: what is the gold standard?Videos These days, most currencies are "fiat" currencies backed by the economies of the countries that issue them. But in days gone by currencies were on the "gold standard". Here's what that means.
