Expansionary Monetary Policy

What is Expansionary Monetary Policy?

Let us discuss what expansionary monetary policy means in the macroeconomic sense. The expansionary policy helps in encouraging economic growth by increasing the money supply, lowering interest rates, increasing aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices.read more. One of the forms of expansionary policyExpansionary PolicyExpansionary policy is an economic policy in which the government increases the money supply in the economy using budgetary tools. It is done by increasing the government spending, cutting the tax rate to increase disposable income etc.read more is monetary policy.

Monetary policy refers to the central banks’ actions that affect the quantity of money and credit in an economy in order to influence economic activity. When the rate of growth of the money supply is increased, banks have more funds to lend, which puts downward pressure on interest rates. Lower interest rates increase investment in plant and equipment because of the cost of financing these investments declines. Lower interest rates and greater availability of credit will also increase consumers’ spending on consumer durables (automobiles, large appliances) that are typically purchased on credit. Thus the effect of the expansionary monetary policy is to increase aggregate demand (C=consumption and I=investment increase).

Expansionary-Monetary-Policy

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Expansionary Monetary Policy (wallstreetmojo.com)

Effect on GDP

It is a policy where the central bank utilizes its tools to help in stimulating the economy. This policy acts as the booster for economic growth which is measured by GDP i.e. Gross Domestic Product. This policy is mostly used by the central banks, during recessions, when the interest falls and money supply increases which results in the increase in consumption and investments.

If the economy is at potential GDP due to the implementation of monetary expansion, the increase in real output will be only for the short run.

Elaborating Expansionary Monetary Policy

In situations of high-interest rates, the central bank focuses on decreasing the discount rate. With the fall in the discount rate, consumers and businesses are able to borrow very cheaply. This decreasing interest rate then makes the government bonds and savings accounts less attractive options thus encouraging the investors and savers towards risk assets. But if the interest rates are already on a low then the central bank has the very little option to cut discount rates. Then the central bank purchases government securities which are known as quantitative easingQuantitative EasingQuantitative easing (QE) refers to that non-standard monetary policy whereby the central bank makes an open market purchase of the long-term securities such as government bonds to induce additional money in the economy.read more. Quantitative Easing helps in the stimulation of the economy by reducing the number of government securities in circulation.

Expansionary Monetary Policy Works in the Following Ways

Objectives of Expansionary Monetary Policy

Disadvantages of Expansionary Monetary Policy

The followings are the disadvantages of expansionary monetary policy:

Example of Expansionary Monetary Policy

A very recent example of the expansionary monetary policy was during the Great Recession in the United States. When the housing prices reduced and the economy slowed down significantly, the Federal Reserve started cutting its discount rate from 5.25 in June 2007 to 0% by the end of 2008. The economy still being weak, it started purchasing government securities from January 2009 for a total value of $3.7 trillion.

Conclusion

When the policy rate is below the neutral rate, the monetary policy is expansionary. The expansionary monetary policy is successful because people and corporations try to get better returns by spending their money on equipment, new homes, assets, cars, and investing in businesses along with other expenditures that help in moving the money throughout the system thus increasing economic activity.

Expansionary Monetary Policy Video

 

This has been a guide to what is Expansionary Monetary Policy. Here we discuss the objectives of expansionary monetary policy and its effect on GDP. Also, we discuss the advantages and disadvantages of Expansionary Monetary Policy. You can learn more about economics from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *