Fiscal Policy vs. Monetary Policy: Pros & Cons

Fiscal Policy vs. Monetary Policy 

Fiscal policy and monetary policy are the two tools used by the state to achieve its macroeconomic objectives. To have a stable economy, these two policies must have been effectively managed which are fiscal and monetary policy. Fiscal policy is the use of government spending and tax policies to either stimulate or slow down economy, that is, the Government is trying to stimulate or slow down aggregate demand for goods and services, employment, inflation, and economic growth. It is the combination and interaction of Government expenditures and revenue collection to have an impact on overall economy. The Government uses expansionary fiscal policy during recession by lowering tax rates to increase aggregate demand and increasing its net spending or budget deficit to fuel economic growth. While contractionary fiscal policy is used to curb inflation by increasing both tax rate and budget surplus. In Nigeria, The Federal Ministry of Finance is charged with this responsibility headed by Minister of Finance, who works in-hand with CBN to have a steady and stable economic activities and growth, so as to avoid any underline effect of contradicting policies.

Monetary policy involves the management of the money supply and interest rates by central banks of a country. To stimulate a faltering economy, the central bank will cut interest rates, making it less expensive to borrow while increasing the money supply. If the economy is growing too rapidly, the central bank can implement a tight monetary policy by raising interest rates and removing money from circulation. The authority to formulate and implement monetary policy is vested in the Central Bank of Nigeria (CBN). The conduct of monetary policy by the Central Bank of Nigeria since 2008 has been designed to: influence the growth of money supply consistent with the required aggregate Gross Domestic Product (GDP) growth rate, ensure financial stability, maintain a stable and competitive exchange rate of the naira, and achieve positive real interest rates. The CBN has used this means to control the activities of commercial banks in Nigeria by reviewing either upward or downward the cash reserve ratio (CRR) or loan-to-deposit ratio which currently stood at 27.5% and 65% respectively.

The Pros and Cons of Monetary and Fiscal policy.

Monetary policy as a tool can be used to promote a lower inflation rate since the CBN controls the supply of money in the economy and also, it promotes transparency in terms of low political interference. Unlike monetary policy, the fiscal policy can direct spending toward specific projects, sectors or regions to stimulate the economy where it is perceived to be needed most.

As against the positive impact, the monetary policy can usually take time before having effect on the economy. For instance, if the MPC make any adjustment on the policy rate, it might take time before it becomes effective. Another con of monetary policy is the fact that all policy has an economy-wide impact on the entire country and do not account for the fact that some areas in the country might have economy differences such as different unemployment rate and inflation rate. The Fiscal policy can be politically motivated by not factoring economic data and report in making some policy which makes it difficult to achieve its purpose.

Recent Policy Implemented through Monetary and Fiscal policy in Nigeria.

On the 1st of February, 2020, the government through its Ministry of Finance increased value added tax (VAT) from 5% to 7.5%, this increase came after the Federal Government approved the minimum wage of N33,000 from N18,000. A VAT threshold of N25 million revenue was also introduced (as companies with sales less N25million are classified as small and thus exempt from collecting and remitting VAT. The increase would certainly lead to increase in Government revenue that can be used to fund the payment of the minimum wage. It would also reduce the budget deficit and by implication the debt that would have been acquired to fund the minimum wage.

On the monetary policy front, there has been some measures to cushion the impact of COVID-19 pandemic such as the reduction in Monetary policy rate from 13.5% to 12.5% in May 2020, extension of moratorium by an additional one year on CBN intervention funds, and Restructuring of loan tenors for businesses in affected industries particularly oil and gas, agriculture and manufacturing. All of these efforts are in order to cushion the effect of the pandemic and act as a buffer for economic growth which is expected to be negative in the second quarter of 2020. 

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