Monetary and fiscal policies are closely related, and both have profound impacts on economic development throughout the world. Fiscal policy deals with macroeconomic levers of power. This concludes budgets, debts, deficits and state spending. Monetary policy is often in the hands of bankers, and refers to interest rates, access to credit and inflation rates.
Monetary and Fiscal Stability
Taken together, fiscal and monetary policies create an investment environment. This means that the legal and monetary environment must reward successful entrepreneurs and ensure a fair return on investment. This is accomplished through promoting economic stability, meaning inflation is kept under control and interest rates at a level where loans are fairly easy to get. Rates that are too high harm the economy because money is too expensive. Development must take both inflation and rates into account, and strike a balance between them.
Foreign and Domestic Debt
Dealing with debt is both a monetary and fiscal issue. Excessive debt makes the economy in question a bad risk, and international capital will ignore such places. Debt can mean both internal and external debt. The former concerns budget deficits, while the latter can mean trade imbalances where the country is buying more than it is selling internationally. Debt removes needed liquidity from a country, which in turn can drive up interest rates at home. Needed monies are not there to assist in economic development and/or social spending.
The central bank is normally in charge of monetary policy as the state is normally in charge of fiscal policy. Some central banks, such as in Libya or China, are under state control, while the Bank of England or the American Federal Reserve are private corporations. Either way, the point of the central bank is to control monetary policy to benefit the local economy. Easy money can accompany good economic times, while tighter money can accompany tougher markets. The purpose here is to control the value of the currency. Loose money, that is, cheaper money, might be the needed boost to a flagging economy, or it can be the gateway to runaway inflation.
“Fiscal Space” and Its Importance
“Fiscal Space” is a concept used by the United Nations to refer to a financial cushion in the national budget. This means that the country has sufficient currency in reserve to finance seed money investment, poor relief, education or job training for the sake of economic development and modernization. Indebted countries such as Greece or Argentina have absolutely no fiscal space, and the economy suffers. Countries whose export sectors is boosted by state action, such as China, Belarus or South Korea, are awash in foreign reserves and hence have money to spend on social projects that benefit the economy. The accumulation of foreign reserves are currencies that come into the country due to successful export programs. This can then be reinvested in the economy.
- Comstock/Comstock/Getty Images