When the federal government turns to the nation's financial planning, it has two useful tools at hand: monetary policy and fiscal policy. One of these tools deals with the cost and value of money; the other deals with revenue, budgeting and spending. If a change is needed, the process is quite different for these two policies, and this affects how quickly changes can be made.
The Cost of Money
The Federal Reserve sets monetary policy by declaring a target rate for money it loans to the banks. This "federal funds" rate affects interest rates on a wide variety of loans, such as mortgages, car loans and credit cards. The higher the interest rate, the more expensive it is to borrow money; raising interest rates can put a brake on the supply of money, business investment, economic growth and inflation. Raising rates also tends to support the value of the nation's currency on the foreign exchange markets; the higher the currency goes, the more expensive a country's goods are for foreign importers.
Pulling the Monetary Levers
Changing monetary policy is a simple matter of setting a target federal funds rate, which the Federal Reserve does at regular meetings of the Federal Open Market Committee. In addition, the Fed can make large purchases of government bonds in the open market, which would tend to drive up the value of the bonds and thus lower interest rates. Although the target rate is subject to a simple vote of the board of governors, this policy is out of the control of legislators and the executive branch. The only direct control the government exercises over the Federal Reserve is the appointment of its chairperson by the president -- a selection that is subject to approval by the U.S. Senate.
Fiscal policy refers to decisions about taxes, budgets and spending. Legislators at the state and federal level constantly debate how much money to raise and where to spend that money. Priorities differ from one state to the next and with the budgeting philosophy of various political parties and factions. Legislators seek voter support for their policies and will often change their opinions depending on public sentiment. For that reason, fiscal policy is much harder to change than monetary policy, as it's subject as much to politics and ideology as it is to sound financial planning.
- Federal Reserve: What Is the Difference Between Monetary Policy and Fiscal Policy, and How Are They Related?
- Federal Reserve Bank of Chicago. “The Federal Reserve's Dual Mandate.” Accessed August 13, 2020.
- European Central Bank. “Independence.” Accessed August 13, 2020.
- Board of Governors of the Federal Reserve System. “What does it mean that the Federal Reserve is "independent within the government"?” Accessed August 13, 2020.
- International Monetary Fund. “What Is Keynesian Economics?” Accessed August 13, 2020.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.