Theory and Practice of Fiscal Policy: From Stabilization to Structural Reform

Fiscal Policy is the use of government spending and taxation to influence the economy. It is one of the two primary tools for macroeconomic management—the other being monetary policy (managed by central banks).

In simple terms, fiscal policy is how a government decides to earn money (taxes) and spend money (expenditure) to achieve specific goals like economic growth, full employment, and price stability.

In Nepal, Fiscal Policy is the primary economic instrument used by the Government of Nepal (GoN) to manage the national economy through the annual Federal Budget. It operates via three main channels: government expenditure (G), revenue collection through taxation (T), and public borrowing.

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How do Nepal’s monetary and fiscal policies work together to balance economic stability and growth?

Nepal’s monetary and fiscal policies work together to maintain economic stability and promote growth, especially in response to inflation and budget deficits.

Monetary Policy (Managed by Nepal Rastra Bank - NRB)

Inflation Control: NRB sets an inflation target (around 6.5%) and adjusts interest rates to stabilize prices

Liquidity Management: The central bank uses tools like open market operations and reserve requirements to regulate money supply.

Foreign Exchange Reserves: Nepal maintains reserves to cover imports for 7 months, ensuring economic stability.

Interest Rate Adjustments: NRB lowers rates to encourage borrowing and investment when growth slows.

Fiscal Policy (Managed by the Government)

Budget Deficit Management: Nepal faces challenges with expenditures exceeding revenues, leading to fiscal deficits.

Public Investment: The government prioritizes infrastructure and social programs to stimulate growth.

Taxation & Revenue Collection: Import restrictions were lifted to boost tax collection and reduce the deficit.

How They Work Together?

Inflation Control: NRB adjusts interest rates while the government manages spending to prevent excessive inflation.

Economic Growth: Lower interest rates encourage investment, while government spending supports infrastructure and job creation.

Budget Deficit Management: The government increases revenue through taxation, while NRB ensures liquidity to support economic activity.

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