Fiscal policy and central banks play important roles in managing a nation's economy. Fiscal policy involves government spending and tax policies to influence macroeconomic indicators like employment, inflation and growth. Central banks implement monetary policy by adjusting interest rates and money supply to maintain price stability and economic growth. While both tools aim to boost aggregate demand, fiscal policy can directly target specific groups, and has a faster effect, but also risks creating large deficits. Central banks issue currency, act as lenders of last resort, and set monetary policy to achieve objectives like low inflation. Since the 2008 crisis, central banks have taken on more stimulus roles.

1. THE ROLE OF FISCAL POLICY
AND CENTRAL BANK

2. WHAT IS FISCAL POLICY?
• Fiscal policy is the means by which a government adjusts
its spending levels and tax rates to monitor and influence
a nation's economy. It is the sister strategy to monetary
policy through which a central bank influences a
nation's money supply.

3. HOW FISCAL POLICY WORKS
• Fiscal policy is based on the theories of British economist John
Maynard Keynes. Also known as Keynesian economics, this
theory basically states that governments can influence
macroeconomic productivity levels by increasing or
decreasing tax levels and public spending. This influence, in
turn, curbs inflation (generally considered to be healthy when
between 2-3%), increases employment and maintains a
healthy value of money. Fiscal policy plays a very important
role in managing a country's economy.

4. Who Does Fiscal Policy Affect?
• Unfortunately, the effects of any fiscal policy are not the same
for everyone. Depending on the political orientations and
goals of the policymakers, a tax cut could affect only the
middle class, which is typically the largest economic group. In
times of economic decline and rising taxation, it is this same
group that may have to pay more taxes than the wealthier
upper class.
• Similarly, when a government decides to adjust its spending,
its policy may affect only a specific group of people. A decision
to build a new bridge, for example, will give work and more
income to hundreds of construction workers. A decision to
spend money on building a new space shuttle, on the other
hand, benefits only a small, specialized pool of experts, which
would not do much to increase aggregate employment levels.

5. PROS AND CONS OF FISCAL POLICY
• Fiscal policy refers to the tax and spending policies of a
nation's government. A tight, or restrictive fiscal policy
includes raising taxes and cutting back on federal spending. A
loose or expansionary fiscal policy is just the opposite and is
used to encourage economic growth. Many fiscal policy tools
are based on Keynesian economics and hope
to boost aggregate demand.

6. • Can Direct Spending To Specific Purposes
Unlike monetary policy tools, which are general in nature, a
government can direct spending toward specific projects,
sectors or regions to stimulate the economy where it is
perceived to be needed to most.
• Can Use Taxation to Discourage Negative Externalities
Taxing polluters or those that overuse limited resources can
help remove the negative effects they cause while generating
government revenue.
• Short Time Lag
The effects of fiscal policy tools can be seen much quicker
than the effects of monetary tools.
PROS OF FISCAL POLICY

7. • Can Create Budget Deficits
A government budget deficit is when it spends more
money annually than it takes in. If spending is high and
taxes are low for too long, such a deficit can continue to
widen to dangerous levels.
• Tax Incentives May Be Spent on Imports
The effect of fiscal stimulus is muted when the money
put in to the economy through tax savings or government
spending is spent on imports, sending that money abroad
instead of keeping it in the local economy.
• May Be Politically Motivated
Raising taxes is unpopular and can be politically
dangerous to implement.
CONS OF FISCAL POLICY

8. CENTRAL BANK
• A central bank or monetary authority is a
monopolized and often nationalized institution given
privileged control over the production and
distribution of money and credit. In modern
economies, the central bank is usually responsible
for the formulation of monetary policy and the
regulation of member banks.

9. Issue money. The Central Bank will have responsibility for issuing notes and coins
and ensure people have faith in notes which are printed, e.g. protect against forgery.
Printing money is also an important responsibility because printing too much can
cause inflation.
Lender of Last Resort to Commercial banks. If banks get into liquidity shortages then
the Central Bank is able to lend the commercial bank sufficient funds to avoid the bank
running short. This is a very important function as it helps maintain confidence in the
banking system. If a bank ran out of money, people would lose confidence and want to
withdraw their money from the bank. Having a lender of last resort means that we
don’t expect a liquidity crisis with our banks, therefore people have high confidence in
keeping our savings in banks.

10. • Lender of Last Resort to Government. Government borrowing is financed by selling
bonds on the open market. There may be some months where the government
fails to sell sufficient bonds and so has a shortfall. This would cause panic amongst
bond investors and they would be more likely to sell their government bonds and
demand higher interest rates.
• Target low inflation. Many governments give the Central Bank a target for
inflation, e.g. the Bank of England has an inflation target of 2% +/- 1. See: Bank of
England inflation target. Low inflation helps to create greater economic stability
and preserves the value of money and savings.
• Target growth and unemployment. As well as low inflation a Central Bank will
consider other macroeconomic objectives such as economic growth and
unemployment.
• Operate monetary policy/interest rates. The Central Bank set interest rates to
target low inflation and maintain economic growth. Every month the MPC will
meet and evaluate whether inflationary pressures in the economy justify a rate
increase. To make a judgment on inflationary pressures they will examine every
aspect of the economic situation and look at a variety of economic statistics to get
a picture of the whole economy.

11. WHY DO WE HAVE CENTRAL BANKS?
• Governments first started establishing central banks
in order to create reliable payment systems. Over
time the banks’ mandate increased to managing
whole financial systems and economies. Their main
approach has been to adjust the cost of money by
changing interest rates: at first in an effort to
stimulate or slow the economy and later more as a
way of preserving stability.

12. WHERE DO CENTRAL BANKS GET
THEIR MONEY?
• There’s more than one way to boost or reduce the amount of money in a
banking system – and more widely, an economy. We might imagine the
central banks simply print new notes, for instance, but the reality is more
complicated. Most new money is actually electronic.
• When it comes to controlling the amount of money in an economy, central
banks use one of three tools.
• 1. Adjust short-term interest rates. Lower rates increase the supply of
money and boost economic activity, while higher rates have the opposite
effect.
• 2. Modify reserve requirements. These are the amount of money banks
must hold against deposits in bank accounts. When reserve requirements
are lower, banks can lend more money, and this increases the overall
supply of money.
• 3. Conduct open market operations. In order to increase the money
supply, central banks can buy government securities on the open market,
and sell them to receive cash.

13. How has their role changed?
• Since the 2008 financial crisis, central bankers have become more
important. Particularly in the United States and Europe, they are
generally viewed as making the difference between a continued
feeble recovery and flat-out disaster. As governments rein in
spending, they have stepped in to stimulate suffering economies.
• With growth and investment still low, some central banks have
ventured into unfamiliar territory: zero or negative interest rates
and massive quantitative-easing programmers in Europe, Japan and
the US.
• This has led to major challenges for central bankers. First, many
countries have found themselves stuck in an environment of low
interest rates, from which they struggle to claw out. With growth
still low and prices flat or deflationary, there is great pressure to
leave rates where they are, so as not to damage a still tentative
recovery.