Monetary vs Fiscal Policy

Monetary Policy (Federal Reserve / FRB)

Controls money supply and interest rates

Fed Tools:

• Open Market Operations (OMO) — most frequently used tool
• Buy bonds = inject money = EXPANSIONARY (rates ↓)
• Sell bonds = drain money = CONTRACTIONARY (rates ↑)
• Discount Rate — rate charged to banks borrowing from the Fed
• Lower rate = easier to borrow = EXPANSIONARY
• Raise rate = harder to borrow = CONTRACTIONARY
• Reserve Requirements — % of deposits banks must hold
• Lower reserves = banks lend more = EXPANSIONARY
• Higher reserves = banks lend less = CONTRACTIONARY
• Federal Funds Rate — target rate for overnight interbank lending
• FOMC (Federal Open Market Committee) sets the target

Expansionary Policy (stimulate economy / "easy money")

• Buy bonds, lower rates, lower reserves
• Increases money supply → rates fall → borrowing/spending increases
• Risk: inflation

Contractionary Policy (slow economy / "tight money")

• Sell bonds, raise rates, raise reserves
• Decreases money supply → rates rise → borrowing/spending decreases
• Goal: fight inflation

Fiscal Policy (Congress & President)

• Government spending and taxation
• Expansionary: increase spending, cut taxes → stimulates economy
• Contractionary: cut spending, raise taxes → slows economy
• Tools: tax rates, government spending, transfer payments