Policy Mix

DEFINITION of 'Policy Mix'

The combination of fiscal and monetary policy a nation's policymakers use to manage the economy.

BREAKING DOWN 'Policy Mix'

Economic policy consists of two major parts: fiscal policy, which encompasses taxes and government spending; and monetary policy, which encompasses the money supply and interest rates. In most democratic countries, elected legislatures control fiscal policy, while independent central banks handle monetary policy.

Governments and central banks generally share a broad set of aims: low unemployment, stable prices, moderate interest rates and healthy growth. They employ different tools to accomplish these goals, however, and often stress different priorities. Government budgets affect long-term interest rates, for example, while monetary policy affects short-term ones. Governments must win popular approval, while central bankers are technocrats that do not directly answer to voters.

At times fiscal and monetary policymakers work together. For example, the government might pass fiscal stimulus, cutting taxes and increasing spending. The central bank might provide monetary stimulus by cutting short-term interest rates. This was the policy mix that, broadly speaking, characterized the U.S.'s response to the 2008 financial crisis.

At other times fiscal and monetary policy can push in different directions. The central bank might ease monetary policy while fiscal policymakers pursue austerity, as happened in Europe following the financial crisis. Or the government, eager to win popular support, might cut taxes or boost spending despite a tight labor market and inflationary pressures. Those actions could force the central bank to raise interest rates.