Monetary & fiscal policiesFiscal policyandmonetary policyare the two tools used by the State to achieve itsmacroeconomicobjectives. While the main objective of fiscal policy is to increase the aggregate output of the economy, the main objective of the monetary policies is to control the interest and inflation rates. The fiscal policies have an impact on the goods market and the monetary policies have an impact on the asset markets and since the two markets are connected to each other via the two macrovariables output and interest rates, the policies interact while influencing the output or the interest rates.For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa. If they behave as strategic complements,then an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of other. The issue of interaction and the policies being complement or substitute to each other arises only when the authorities are independent of each otherActive and passive monetary and fiscal policiesPassive fiscal policy is one in which the authority raises or reduces taxes to balance the budget intertemporally.Active fiscal policy is one in which the tax and spending levels are determined independent of intertemporal budget consideration.Active monetary policy is one that pursues its inflation target independent of fiscal policies.Passive monetary policy is one that sets interest rates to accommodate fiscal policies.In case of an active fiscal policy and a passive monetary policy, the economy faces an expansionary fiscal shock that raises the price levels and money growth as monetary authority is forced to accommodate these shocks. But in case both the authorities are active, then the expansionary pressures created by the fiscal authority is contained to some extent by the monetary policies.Monetary policyis a term used to refer to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth.Fiscal policyis a broad term used to refer to the tax and spending policies of the federal government. Fiscal policy decisions are determined by the Congress and the Administration; the Federal Reserve plays no role in determining fiscal policy.Reserve Bank of India states that, Monetary policy refers to the use of instruments under thecontrol of the central bank to regulate the availability, cost anduse of money and credit. Objectives Maintaining price stability Ensuring adequate flow of credit to the productive Sectorsof the economy to support economic growth Rapid economic growth Balance of payment equilibrium Full employment Equal income distributionFACTORS AFFECTING MONETARY POLICYMonetary policy and fiscal policy lacks coordination Time lag affects success of monetary policy Money not appearing in an economy Existence of unorganized financial market Excess of non-banking financial institutions (NBFI) There exist a non-monetized sectorMeaning Fiscal policy deals with the taxation and expenditure decisions of the government. These include, tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus managementOBJECTIVES OF FISCAL POLICY Increase in capital formation. Degree of Growth. To achieve desirable price level. To achieve desirable consumption level. To achieve desirable employment level. To achieve desirable income distribution.

The Two Main instruments of fiscal policy Revenue Budget

Expenditure BudgetFiscal Policy there are three possible positionsA Neutral position applies when the budget outcome has neutral effect on the level of economic activity where the govt. spending is fully funded by the revenue collected from the tax. An Expansionary position is when there is a higher budget deficit where the govt. spending is higher than the revenue collected from the tax. An Contractionary position is when there is a lower budget deficit where the govt. spending is lower than the revenue collected from the tax.