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Home / IAS Preparation / Monetary Stimulus vs Fiscal Stimulus

Difference between Monetary Stimulus and Fiscal Stimulus - UPSC Notes!

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Monetary and Fiscal Stimulus are two of the main tools the Government has to stabilize the economy during financial crises. Two of the key tools the government has to stabilize the economy amid financial crises are fiscal and monetary stimulus. These are the attempts made by decision-makers to stimulate the economy using a combination of monetary and financial tools.

Fiscal stimulus refers to raising government spending or reducing taxes. While monetary stimulus refers to interest rate reductions or other methods of raising the amount of money or credit. In this article, we shall discuss the difference between Monetary Stimulus and Fiscal Stimulus which is one of the most important topics for the UPSC IAS exam. It also covers a significant part of General Studies paper-3 syllabus.

Also, read in detail about the Economic Survey 2021 here!

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What is Fiscal Stimulus?
  • A collection of government policies known as “Fiscal Stimulus” are intended to kick-start a lethargic economy.
  • The central bank will either boost the money supply or reduce the cost of money to encourage consumer expenditure (interest rates).
  • A fiscal stimulus is when the government increases expenditure from its own funds or lowers tax rates to increase consumer spending.
  • For instance, the central government offered a fiscal stimulus package worth Rs. 20 lakh crore during the COVID-19 pandemic.

Study in detail about Fiscal Consolidation for UPSC here!

What is Monetary Stimulus?

Monetary stimulus is how central banks control the amount of money available to the economy of a country. Typically, there are two ways to accomplish this:

    • The first method is to lower market interest rates, which will motivate companies to invest as borrowing will be more affordable, thus boosting the economy
    • The second method is the money supply as they may raise it by simply putting more money into the system.
  • Therefore, although the central bank makes money, it does not literally print it. It electronically raises the quantity of money it has.
  • This means that in order to control the amount of money in circulation, the government raises the amount of money in the economy and lowers access fees.
  • For instance, they purchase bonds from banks to eventually grow their cash reserves, which will lower the cost of money and encourage banks to extend loans to individuals and companies.

Let us study the difference between Monetary Stimulus and Fiscal Stimulus in detail below.

हिंदी में भी जानें : मौद्रिक और राजकोषीय प्रोत्साहन के बीच अंतर 

Difference between Fiscal Stimulus and Monetary Stimulus

An economy frequently experiences financial crises, and to counteract these negative impacts, the governments in question release fiscal and monetary stimulus packages. When output and employment levels are much below what is sustainable, or when there is a recession, both monetary and fiscal stimulus packages are used. But due to a variety of other reasons, there are many differences between Monetary Stimulus and Fiscal Stimulus and they are essentially distinct from one another.

The difference between Fiscal Stimulus and Monetary Stimulus is given in the table below:

Fiscal Stimulus Monetary Stimulus
  • A government-controlled strategy known as fiscal stimulus involves altering government expenditure and taxation in order to boost the economy.
  • In order to affect total supply and demand, the government employed fiscal stimulus packages that reduced taxes, increased expenditure, and sped up economic growth.
  • The government implements fiscal stimulus through direct expenditure and increased hiring to support employment and growth.
  • The last recourse for achieving price stability, consistent economic growth, and employment promotion are fiscal stimulus programmes.
  • The central banks, which aim for low inflation and stabilise economic development by making more money accessible, are in charge of the monetary stimulus.
  • A monetary stimulus is a model of policy that central banks use to control the amount of money in a nation. Interest rates are the main monetary stimulation tool.
  • The monetary stimulus functions in the following ways:
  1. Promoting company investment by a drop in marketing interest rates.
  2. By putting more money into the economy, the money supply is increased.
  • During recessions, a monetary stimulus puts extra money in people’s pockets

Study in detail about Monetary Policy here!

Fiscal Stimulus

How Does Fiscal Stimulus Work?

The following options exist for the government’s use of fiscal policy to boost the economy:

  • Spending on the government is rising
    • Government spending growth stimulates the economy by injecting additional funds.
    • As a result, the demand for products and services may rise, which may support economic growth.
  • Incentive taxes
    • Tax incentives are occasionally used to entice consumers and corporations to invest in ventures that will be profitable for them.
    • Due to the fact that it injects more money into the economy to support its expansion, this might have a similar impact on boosting government spending.
    • However, depending on the kind of tax cut they offer, tax incentives can also promote particular behaviors.
    • For instance, a decrease in income taxes might motivate people to put in more effort so they have more money available at the end of each pay period. Raising consumer spending and employment levels would promote economic growth.
  • Direct Payment of Money to Customers or Businesses
    • The government used the technique of issuing “stimulus checks” or cash assistance to individuals directly during the period of the Great Recession.
    • The goal is to encourage consumer spending by giving consumers and businesses more money to spend.
    • Because people are more likely to save when they are unsure about the direction of the economy, it can also have a reverse impact.
    • When customers do not purchase things with the money from their stimulus checks, businesses will not make enough money from their services or commodities, and economic growth may be hindered.

Study in detail the Goods and services tax (GST) here.

How Does Fiscal Stimulus Help the Economy?

  • Fiscal stimulus is one type of short-term economic stimulus that tries to increase current economic activity by promoting consumption and investment.
  • Economic stimulation may persuade enterprises to invest more money in their operations or in initiatives that will generate income in the future.
  • Additionally, since the opportunity cost of not spending more money, is lower if consumers receive money from the government, it encourages them to spend more during tough economic times.
  • When consumer spending rises, firms make more money, and employees who may have been worried about losing their jobs during a recession are given jobs.
  • As a Last Resort Spender: When the private sector is not spending enough money to promote economic growth, the government steps in as the spender of last resort by boosting its expenditures.
  • The Last-Resort Payer: When there aren’t enough jobs available, the government serves as a payer of the last option by paying money directly to people.

Study in detail about Inflation for UPSC here!

Impacts of Fiscal Stimulus Framework

The impacts of the Fiscal Stimulus framework are as follows:

  • The fiscal stimulus causes a sharp increase in liquidities and can also lead to widespread bankruptcies, losses in organizational capital, and a difficult road to economic recovery.
  • There is a liquidity preference because practically everyone prefers holding cash, which can lead to a liquidity trap where the rate of interest declines.
  • It may lead to significant inflation.
  • Fiscal stimulus comprises spending on things like food, health care, and income support for low-income people, all of which can strain the government coffers.
  • It may result in worsening state finances by raising the gross public debt, affecting credit ratings, etc.

Study the Impact of a High Debt to GDP Ratio on the Economy here.

Monetary Stimulus

How Does Monetary Stimulus Work?

Monetary stimulus works by raising the amount available for borrowing. Usually, one of these two approaches is used:

  • Making Loans By lowering the interest rates that banks must pay on reserves that they store at the central bank, lending can be made more affordable. This is called the “Policy Rate”.Banks are more likely to lend money to individuals and companies when the policy rate is cut since borrowing money costs less.
  • The acquisition of bonds from banksBonds issued by banks may also be purchased by the government. When the government purchases a bond, it pays the bond’s face value and interest. The government’s purchase of bonds increases the amount of money in circulation, which promotes borrowing and lending.

Also, check out article on Black Money here.

How Does Monetary Stimulus Help the Economy?

  • As clients decline during an economic downturn, firms will experience lower and slower revenue. This will eventually pressure companies to attempt and cut operating expenses by firing employees or shutting operations.
  • Workers automatically start saving out of fear of losing their source of income, which slows down the flow of money throughout the economy.
  • Monetary stimulus is intended to expand the money supply in the hopes that this will enhance consumer spending and investment, which will aid in accelerating economic growth.
  • Interest rates are frequently lowered as a result of monetary stimulus, making borrowing more affordable. When borrowing money is affordable for businesses, they are more likely to do it.
  • Additionally, because the opportunity cost of saving becomes less appealing, it encourages customers who have saved money to spend it rather than saving it.
  • Businesses are more likely to invest in new projects when customers are seen making purchases since there is a greater demand for their products.
  • More investments equate to more jobs, therefore it also boosts employment. Instead of relying on government support, this aids people in getting back on their feet financially.

Study in detail about the Structure & Functions of RBI here!

Impacts of Monetary Stimulus Framework

The amount of money that can be lent out before it starts to overheat the economy is normally constrained by monetary policy. Money stimulus in an economy is impacted by monetary policy, which in turn affects interest rates and inflation. Additionally, it affects employment, net exports, business expansion, debt costs, and the relative costs of saving vs spending, all of which directly or indirectly affect aggregate demand.

Fiscal Stimulus during COVID-19
  • There were more job losses during the pandemic, which contributed to an increase in unemployment.
  • Several economic sectors, particularly the manufacturing sector, were negatively hit.
  • The Pradhan Mantri Garib Kalyan Yojana (PMGKY), which is valued at Rs 1.75 lakh crore or nearly 0.8 per cent of the Gross Domestic Product (GDP), was one of the economic aid programmes granted by India.
  • For farmers, cottage industry, Micro, Small and Medium Enterprises (MSME)s, labourers, the middle class, etc., the Atmanirbhar Bharat Abhiyan, worth Rs. 20 lakh crore, was launched.
  • Many nations, like Bangladesh and Indonesia, among others, resorted to increasing the scope of the cash transfer programmes they were already doing before COVID-19.
  • Some countries, like China and Vietnam, have combined efforts to feed hungry families and help laid-off workers in an effort to keep businesses viable.

Study in detail about Types of Unemployment here!

Monetary and Fiscal Stimulus: Which Is a Better Strategy?
  • Using monetary and fiscal stimulus to boost the economy has both benefits and drawbacks.
  • Fiscal stimulus is often employed as a short-term measure, but monetary stimulus can be utilized as both long-term and short-term tools.
  • Demand for products and services can rise as a result of fiscal stimulus, which will support economic expansion. Because people are more likely to save when they are unsure about the direction of the economy, it can also have a reverse impact.
  • A financial stimulus can motivate corporations to invest more money in their businesses or in projects that will increase their revenue in the future.
  • However, because it expands the money supply, it can also cause inflation to rise.
  • Therefore, it ultimately relies on the circumstance and what will have the greatest favorable economic impact.

Download Economy UPSC Notes with the linked article!

Conclusion

Fiscal stimulus supplies the economy with the much-needed liquidity boost that is necessary for various economic activities to resume, especially during a recession. It aids in reviving enterprises, employment prospects, and means of subsistence.

However, in order to prevent problems with the fiscal deficit and the debt crisis from developing, the fiscal stimulus must be backed by a strong framework for debt management.

Study in detail about Economic Planning in India here!

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Difference between Monetary Stimulus and Fiscal Stimulus- FAQs

A fiscal Stimulus is a legitimate tool employed by the government when the economy is performing poorly.

In order to promote consumer spending, the central bank may increase the amount of money available or decrease the cost of money or the interest rate. This phenomenon is known as Monetary Stimulus.

The term "monetary policy" refers to actions taken by the central bank with the intention of affecting the amount of credit and money in an economy whereas the government's decisions regarding taxation and spending are referred to as fiscal policy.

Fiscal stimulus is often employed as a short-term measure, but monetary stimulus can be utilised as both long-term and short-term tool

A government that adopts fiscal stimulus lowers taxes or boosts spending in an effort to boost the economy. People have access to more money when taxes are reduced.
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