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How Does Fiscal and Monetary Policy Impact Your Personal Finance?

What is fiscal policy?

Fiscal policy can be defined as the means by which governments adjust spending levels as well as tax rates to influence a country’s economy.

What is monetary policy?

Monetary policy can be defined as the process by which monetary authorities of a country i.e. the central banks or currency boards control the supply of money by changing interest rates.

Effects of fiscal policy on personal finance

Since fiscal policy is simply about how the government decides to spend money as well as the tax rates/rules it puts in place, fiscal policy has a significant impact on the personal finances of citizens in a country. Government spending takes many forms varying from government investments in development to spending on social security payments, welfare, etc.

When a government spends more on development, there is a positive impact on the economy. For instance, more jobs are created, and citizens have more money in their pockets to spend on goods and services. When people have more money, they are able to support small businesses which are the main drivers of the economy. The opposite happens when the government lowers spending on development. Unemployment is bound to rise. The price of goods and services also rises making life expensive.

The government’s stand on taxes also has a direct impact on your personal finance. When the government lowers income tax, for instance, citizens have more money to spend on goods and services. This, in turn, propels the industries that make those goods and services boosting the economy in the process. When the income tax is too high, citizens have less money in their pockets which reduces their buying power and slows down the economy.

In a nutshell, your personal finances are bound to be affected favourably when there are favourable tax laws and the government is spending money on things that grow the economy and put more money into the pockets of ordinary citizens.

Effects of monetary policy on personal finance

The monetary authorities of a country i.e. the central banks control the supply of money mainly to boost the economy. Central banks have several of tools for controlling the money supply. For instance, central banks can increase or decrease the amount of reserves banks are required to maintain. This increases or decreases the amount of money banks have for lending to the public as loans. Central banks can also buy or sell financial instruments like bonds to increase or decrease the money supply. Central banks can also raise or lower interest rates to make loans expensive or cheap.

Central banks can maintain tight, neutral or loose monetary policy depending on the performance of the economy. For instance, central banks tend to lower interest rates when there is poor economic growth. This encourages people to borrow since people have more access to cheap loans. This type of monetary policy is accommodative. Central banks can also take tight monetary policy stands i.e. raising short-term interest rates to moderate the pace of economic growth. This usually takes place when inflation is increasing significantly, and central banks want to reduce the amount of money in circulation to stabilise prices.

Monetary policy has a direct and indirect impact on personal finance. The direct impact revolves around the direction of interest rates while the indirect impact revolves around the expectations of economic players. When central banks raise interests, the cost of credit also increases as lenders increase the interest rates charged on loans. New, as well as existing loans, become more expensive. In regards to expectations, potential investors who depend on loans are bound to slow down or stop investing when the cost of loans increases. Monetary policy also has an effect on asset classes such as bonds, equities, real estate, commodities, and currencies. In real estate, for instance, high-interest rates tend to make mortgages expensive.

Summary

Fiscal and monetary policies have a significant impact on every person’s finances. Government spending and tax rates have a significant impact on development, employment, social security payments and overall economic growth which determines how much money citizens have in their pockets. The interest rates set by central banks also determines how much money is circulating in the economy at any given time and this has an effect on how much citizens pay for goods and services.
You must strive to understand fiscal and monetary policy in-depth for you to be able to make smart personal finance decisions.

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Money

What Does Low Inflation Actually Mean For A Countries Economy?

Before assessing the effect of low inflation on a country’s economy, it’s important to define the term inflation.

What is inflation?

Inflation is a term commonly used to refer to the general increase in prices of goods and services. Inflation is measured as an annual % increase. As inflation increases, the purchasing power of every pound decreases. For example, if the inflation rate is 3%, then a £1 loaf of bread will cost £1.03 in one year.
Ideally, the price of goods and services is bound to increase over time. The rise should, however, be gradual otherwise, the economy will suffer. Let’s shift our focus to the effects of inflation on the economy for us to understand the effects of low inflation.

Inflation effects

When prices of goods/services increase, the cost of living also increases. It also becomes more expensive to conduct business in a country with high inflation. The cost of borrowing increases. There is also a corresponding increase in corporate as well as government bond yields. As a result, inflation can have negative as well as positive effects.

If inflation is controlled i.e. kept at low or at reasonable levels, the economy of the country in question prospers. The opposite happens when inflation is too high. Low inflation boosts employment. When people are employed, they have more money to spend. When people are buying more goods and services, the economy grows.

The full impact of low inflation in regards to economic recovery can’t, however, be assessed with unmatched accuracy. To understand this in-depth, it’s important to assess the effects of low inflation on economic metrics such as; the GDP, cost of borrowing and the consumer price index.

Effects of low inflation on GDP

The GDP (Gross domestic product) of a country is simply the value of all goods/services produced by that country. GDP is expressed as a percentage and adjusted for inflation. For instance, if the growth was 8%, but the inflation was 3%, the GDP would be 5%. Low inflation is, therefore, good for the GDP or overall growth of the economy.

Effects of low inflation on cost of borrowing

Theoretically, low inflation can help a country’s economy to recover from depression or recession. The interest rates must, however, be low for this to happen. Low inflation and low interest rates decrease the cost of borrowing encouraging people to take loans and invest or spend. Low-interest rates may, however, make banks reluctant to issue loans since the returns on loans are equally low. A low inflation and low-interest rate environment may, therefore, have a negative effect on consumption.

Low interest rates over a prolonged period of time coupled with low inflation assure the business community of fixed costs. Business owners are able to plan better i.e. when to borrow, market, hiring as well as expand in low interest/low inflation environments. Investors are also in a better place to calculate returns on investments on corporate and government bonds. It’s, however, worth noting that that the effects of low inflation may vary in regards to borrowing.

Effects of low inflation on the consumer price index

Inflation is usually measured by considering the price of essential goods and services as opposed to all goods and services. Inflation focuses on consumables (in the consumer price index) like food prices as well as the price of clothing, housing, energy, education, medical care, communication, and recreation. If the price of all goods/services in the consumer price index increases by say 4%, the rate of inflation is pegged at 4% and the purchasing power decreases by 4%. Low inflation is good since it ensures the cost of essential goods and services remains stable.

Summary

Low inflation is beneficial to the economy on almost every level from the GDP to the cost of borrowing and price of essential goods and services. Low inflation is particularly beneficial to a struggling economy since it helps to keep a check on the price of essentials and also encourages people to borrow and spend. Low inflation must, however, be supplemented by low-interest rates for it to encourage borrowing and spending.