Fiscal Policy and Monetary Policy
The two toolkits a government uses to manage the economy: fiscal policy through spending and taxation, with the balanced budget and budget deficits and surpluses, and monetary policy through changing interest rates to control inflation.
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Two toolkits for the economy
When a government wants to speed up a weak economy or cool down rising prices, it reaches for one of two toolkits. Fiscal policy works through spending and taxation. Monetary policy works through the level of interest rates. This module looks at what each one does and when a government would use it.
Policy words to know
Learn these before you sort the tools.
Fiscal against monetary
The two toolkits pull different levers.
Name the tool, then the direction
In the exam, name the toolkit first: fiscal for spending and taxation, monetary for interest rates. Then state the direction, up or down, and link it to the aim, such as cooling rising prices or lifting a weak economy. Do not mix the two toolkits together in one sentence.
Match the term
- fiscal policy
- monetary policy
- a budget surplus
- a budget deficit
- changes government spending and taxation
- changes the level of interest rates
- tax collected is more than spending
- spending is more than tax collected
Cooling inflation
Prices are rising too quickly. What might monetary policy do to slow this down?
- Raise interest rates so people borrow and spend less.
- Lower interest rates to boost spending.
- Increase government spending.
- Cut taxes for everyone.
Spot the fiscal tools
Select the TWO actions that are fiscal policy.
- Raising the level of taxation
- Increasing government spending
- Raising interest rates
- Changing the money supply
Work out the deficit
In one year a government collects 100 units in tax and spends 120 units. Subtract the tax from the spending to find the size of its budget deficit. What is the answer?
Order the fiscal boost
A government cuts taxes to lift a weak economy. Put the effects in order, earliest first.
- Taxes are cut
- Households have more to spend
- Firms sell more goods
- Firms take on more workers
Complete the summary
_____ policy uses government spending and taxation, while _____ policy uses interest rates to control inflation. When a government spends more than it collects in tax, it runs a budget _____. To cool an economy where prices are rising, policymakers may _____ interest rates.
Match the aim to the action
- boost a weak economy
- slow down rising prices
- run a balanced budget
- reduce a budget deficit
- cut taxes and spend more
- raise interest rates
- match spending to tax income
- spend less or tax more
Spot the monetary tools
Tap the TWO actions that are monetary policy.
- raising interest rates
- changing the money supply
- raising taxation
- increasing government spending
Fiscal or monetary?
Read each measure and choose which toolkit it belongs to.
- A government raises the level of taxation to reduce its deficit. Which toolkit is this?
- Policymakers lower interest rates to encourage borrowing and spending. Which toolkit is this?
- A government increases its spending on new roads to create jobs. Which toolkit is this?
Explain the two policies
Explain the difference between fiscal policy and monetary policy, and give an example of how each could be used to manage the economy.
- Define fiscal policy and give one example of a fiscal action
- Define monetary policy and give one example of a monetary action
- Explain what a budget deficit is and one way to reduce it