2 - THE SCOPE AND ROLE OF FISCAL AND MONETARY POLICIES

Summary

Fiscal policy consists of measures related to central and local government revenue and expenditure. Monetary policy consists of the measures which affect the supply of money and credit and the rate of interest. Changes in the supply of money and in the rate of interest are generally closely interrelated in the sense that, other things being equal, an increase in the supply of money and credit is likely to produce a fall in the rate of interest, and vice versa. A broader definition of monetary policy adopted here includes also measures taken to change the exchange rate.

An important reason for linking fiscal to monetary measures in the analysis of government policies is that the former have a direct bearing on the supply of money and/or on the market rates of interest. A budget deficit, for example, will have the effect of increasing the supply of money unless the entire deficit is financed by borrowing from the private sector in which case market rates of interest will tend to rise. This explains why monetary policies aimed at restricting the growth in the supply of money almost invariably entail deflationary fiscal measures directed at restricting budget deficit by curbing Government outlays and/or increasing tax revenue (see pp. 260–1).