Thread by @AdliAmirullah

Since I have time to spare, I wanna share with you guys what is the difference between Fiscal Policy and Monetary Policy.

After so long, this will be another Economics 101 thread of mine!

https://twitter.com/AdliAmirullah/status/1243507302545510400

To begin with, you must understand that a federal government is NOT equivalent to a central bank. In our case, the federal government is those in the executive seats like the prime ministers and his cabinet members. Whereas the central bank is our Bank Negara Malaysia (BNM).

The one that in-charge to lead the federal government is the prime minister. Whereas the one that in-charge to lead the central bank is the BNM governor. Both of this entity is very important for any country to remain stable economically speaking.

We can't simply combine the federal government with a central bank, because both have a different role in the economy. Imagine you are working in a company where you have an HR department and finance department, both have it's own role right?

Both HR and finance department despite having a different role in a company, they need to work together by sharing data with each other and ensure the hiring process of the company in line with the company's financial situation.

Above analogy is the same as the relationship between the Federal Government and the Central Bank. Both of this entity will be seen to work together to achieve a common goal.

P/S: Different country have different synergy between their government and their Central bank

I might simplify too much here, but for the sake of general understanding, the rule of thumb is:
1. Fiscal Policy is a tool for the federal government (Kerajaan)
2. Monetary Policy is a tool for a central bank (BNM)

1. What is Fiscal Policy? In layman term, Fiscal Policy is a tool for Kerajaan to use to fix the economy. In the tool, there are 2 'weapons' that the government can do to fix the economy:

Weapon 1: Taxation
Weapon 2: Spending

Weapon 1: Taxation

Taxation is where government tax you for your annual income, for the company's profit, and for your SST that you paid every time you purchase something at the mall. Part of the method that the Kerajaan can use this weapon is by reducing or increasing tax rate.

To take an example from Malaysia COVID-19 Economic Stimulus Package, let's look at the first stimulus package on 27th Feb. Under it, the government announced a service tax exemption of 6% for the hotel under the tourism industry. This is a taxation weapon under the fiscal policy.

So in simple term, whenever the government play with tax rate or tax exemption or tax initiatives, it is a fiscal policy that uses taxation as its weapon.

Weapon 2: Spending

Spending means whatever the government spend in the economy. For example from the latest COVID-19 Economic Stimulus Package on 27th March, the government announced that they will provide a total of RM10.1 billion worth of cash to any eligible recipient.

That RM10.1 billion (RM1.6k for 4mil people, RM1k for 1.1mil people, RM800 for 3mil people, and RM500 for 400k people) is an example of government spending. Another example, if you look at the announcement, the government allocated an additional RM500mil for KKM.

In a simple way to understand this, any expenditure made by the federal government should be considered as fiscal policy. A more classic example is if the government build new bridge, or a new school, or a new road, or a new hospital, these will fall under the fiscal policy.

2. What is Monetary Policy? In layman term, it is a policy on how our Bank Negara can control the money supply. What is the money supply? It is all the money you see in front of you or in your ATM screen, those are the money supply in the economy.

There are many weapons that BNM can use to control the money supply. I'll share the basic with you guys since it can be very complicated even for myself. The basic 'weapon' that BNM can use to control monetary policy:

Weapon 1: Interest rate
Weapon 2: Open Market Operation

Weapon 1: Interest Rate

Have you heard about BNM making announcement this month where they cut Overnight Policy Rate (OPR)? This news is the latest announcement of OPR Cut by BNM thestar.com.my/business/busin…

So this OPR is another name that we used under the monetary policy. There are many types of interest rate, I'll explain the simplest one to make you understand how a central bank can play with the interest rate to control the money supply.

Ok for simplicity purposes, imagine you want to buy a house cost RM100,000. The interest rate let say 5% per year. To simplify things, let say the total loan that you need to get from your bank is about RM250,000 (RM100,000 house price + 30 years interest of RM5,000 per year).

From the previous example, u will need to spend a total of RM250k to pay off your house loan. Let say interest rate has been reduced from 5% to let say 3%. Now the total loan you need to pay for the house is about RM190k (RM100k house price + 30 years interest of RM3k per year)

Can you see how much you 'save' from RM250k to RM190k? You will have 'extra' money at hand around RM60k if u decide to buy a house when the interest rate is low.

Imagine if we have thousands of people like you manage to have this 'extra' money. This 'extra' money is what is meant by increased money supply in the economy. That my friend, how most of the interest rate work as monetary policy.

Weapon 2: Open Market Operation (OMO)

OMO is a place where the central bank buying and selling government bond. What is a government bond? In the simplest term, government debt.

Let me portray this in a simple way: Imagine a central bank has a piece of paper. In that paper, it states that whoever buys that paper, the government owe that person let say RM1 million. So when the central bank sells that paper, someone or some entity will buy it.

Let say you buy the paper for whatever reason that cost you RM1 million. So when you get the paper, you transfer the RM1 mil to the central bank. Now your money in your bank is lesser after you purchase the paper right? This is an indication that the money supply has decreased.

Some of you might ask, why someone would want to buy that paper? Well my friend, some people like to buy government bond because it is a ‘confirm money’.

Meaning, when I buy government bond worth let say RM1 mil, when I sell it let say in 10 years, I will get more than RM1 mil based on the interest rate applied. That is my future income.

That is why some people or company like to buy government bond since it has lower risk compared to other corporate bonds.

That is all from me. I know I have simplified a lot in explaining Fiscal Policy and Monetary Policy. My apologies if some of the expert that is reading this. I am trying my best to share my knowledge with everyone here.

Hope this can give a clearer picture of how to differentiate between these two. If you really want to know more about Fiscal Policy, this video might be useful for you:

If you want to know more about Monetary Policy, watch this video:

P/S: If you are watching the video, please take note that “The Fed” that they referring to is the name of the central bank in the US.

Akhir kata, remember to wash your hand frequently with soap, and keep #SocialDistancing people! Sending love and prayer to everyone out there fighting for us. May Allah protect them always.