Fiscal policy, implemented through government spending and taxation, can increase consumer and business spending by directly injecting money into the economy. For example, increased government expenditures on infrastructure projects create jobs, raise incomes, and stimulate demand for goods and services. Tax cuts can leave consumers and businesses with more disposable income, encouraging spending and investment.
Monetary policy, controlled by a country's central bank, influences economic activity primarily through interest rates and money supply. Lowering interest rates makes borrowing cheaper, which can lead to increased consumer and business spending on loans for consumption, investment, and expansion. Additionally, quantitative easing can increase liquidity in the financial system, encouraging lending and spending.
Fiscal policy impacts the federal budget directly, as changes in government spending and tax revenues affect budget deficits or surpluses. Increased government spending or tax cuts can lead to higher deficits, while cuts in spending or higher taxes may help reduce them. In contrast, monetary policy does not directly affect the federal budget but can influence economic conditions that impact tax revenues and expenditures over time.