How To Tell The Difference Between Fiscal and Monetary Policy

As some of you are aware, I have spent the day in irritation at people who simply will not give up on inflation no matter what anyone tells them. In an article earlier today I pointed out that the errant thinking of one such person was due to their inability to understand the difference between monetary and fiscal policy. Whilst dealing with other things today, I thought for a while on how best to convey the difference between the two policies to the average person. I think I’ve found a solution:

Dog crap.

That’s right. Dog crap. I shall endeavor to explain the difference between monetary policy and fiscal policy using dog crap as an example.

Let us suppose you have a rather large dog. Could be a doberman. Could be a husky. Who cares, really. Feel free to imagine any large dog. Now then, let us assume that this large dog of yours craps on your living room floor. It’s quite a land mine. Just look at that huge pile.

That’s fiscal policy.

The dog just added some dog crap to your living room where before, there was none. Next, I want you to grab something sanitary, pick up the dog crap and carry it to the toilet. Now drop it in and flush it down and out of the house forever.

That’s taxation. That’s fiscal policy. Dog crap added, dog crap removed forever.

Now then, I want you to allow fiscal policy to operate and again let the dog crap in your house. There you go – Another land mine on the living room floor. But wait! Don’t pick up the dog crap and flush it away. This time, I want you to do something gross.

Go get a knife.

Now then, I want you to cut the single large pile of dog crap into four pieces.



Next, I want you to leave one of the smaller pieces on the living room floor and using something sanitary, pick up the other three pieces of dog crap. Place one on the kitchen floor, one on the dining room floor and, I don’t know, put one piece on the stairs if you have stairs. Also, let the dog out. We don’t want any more fiscal policy operating at this point.
So, in summary, you had one large pile of dog crap, but now you moved some of it to the kitchen, dining room and stairs. Is there more dog crap than you had when you started, or did you just move some crap around to different rooms? You just moved some crap around, didn’t you? Of course. Clearly there isn’t any more dog crap added to your house. Just some crap moved around here and there.
That’s monetary policy.

Monetary policy cannot create inflation for that very reason. It just moves dollars around between accounts and swaps assets for dollars which is nothing more than a portfolio composition change. Raising or lowering interest rates, again, only shifts dollars around between those who borrow and those who save. You need fiscal policy to create inflation. However, even if we allowed fiscal policy to create an inflationary episode, we have a toilet called “taxation” to flush some of those excess dollars out of the economy forever.

So, perhaps now you understand the difference between fiscal and monetary policy and why monetary policy can’t create inflation. And anyone who says monetary policy can create inflation, well…

that’s just a bunch of dog crap.