EXPANSIVE MONETARY POLICY: CHARACTERISTICS AND ADVANTAGES - ECONOMY - 2024

The expansionary monetary policy is a policy introduced by the monetary authorities to expand the money supply and boost economic activity, primarily by keeping interest rates low in order to encourage borrowing by businesses, individuals and banks.

An expansionary policy is a macroeconomic policy that seeks to stimulate economic growth or combat the increase in inflationary prices by expanding the money supply, reducing interest rates, increasing public spending or reducing taxes.

One form of expansionary policy is fiscal policy, which translates into tax cuts, transfer payments, reimbursements, and increased public spending on projects such as infrastructure improvements.

Another form is monetary policy, which is enacted by central banks and is produced through open market operations, reserve requirements and setting interest rates. The most common form of expansionary policy is through the implementation of a monetary policy.

characteristics

Expansive monetary policy involves lowering interest rates or increasing the money supply to boost economic activity.

It occurs when a central bank uses its tools to stimulate the economy. That lowers interest rates, and increases money supply and aggregate demand. It drives growth that is measured by gross domestic product.

Expansive monetary policy prevents the contraction phase of the business cycle. However, it is difficult for the authorities to capture this contraction in time. As a consequence, the use of expansionary policy is usually seen after a recession has started.

An expansionary monetary policy may imply quantitative easing, whereby central banks acquire assets from banks. This has the effect of reducing the yield on bonds and creating cheaper loans for banks.

This, in turn, increases the ability of banks to make loans to individuals and businesses. However, an expansionary monetary policy also runs the risk of increasing inflation.

How does expansionary monetary policy work?

If the Central Bank reduces interest rates, it will tend to increase the general demand in the economy.

Lower interest rates make it cheaper to borrow, encouraging businesses to invest and consumers to spend. They also reduce the cost of mortgage interest repayments. This gives households a higher disposable income and encourages spending.

Lower interest rates reduce the incentive to save and lower the value of the currency, making exports cheaper and increasing the demand for exports.

In addition to cutting interest rates, the Central Bank could apply a quantitative easing policy to increase the money supply and reduce long-term interest rates.

With quantitative easing, the central bank creates money. It then uses this created money to buy government bonds from commercial banks. In theory this should:

- Increase the monetary base and the banks' cash reserves, which should allow a greater supply of credit.

- Reduce interest rates on bonds, which should help investment.

Advantage

Expansion policy is a useful tool for managing periods of low growth in the business cycle, but it also involves risks. Economists must know when to expand the money supply to avoid causing side effects, such as high inflation.

There is also a time lag between when the policy is implemented and the period when it makes its way into the economy. This makes up-to-the-minute analysis nearly impossible, even for the most seasoned economists.

Prudent central bankers and policymakers must know when to halt the growth of the money supply or even reverse course and move to a contractionary policy, which would imply taking opposite steps of expansionary policy, such as raising interest rates.

In theory, expansionary monetary policy should lead to higher economic growth and lower unemployment. It will also cause a higher rate of inflation.

Economic growth

Expansive monetary policy stimulates economic growth during a recession. Adding money to the economic system lowers interest rates and eases credit restrictions that banks apply to loan applications.

This means that consumers and businesses can more easily borrow money, leading them to spend more money.

High employment

When consumers spend more money, businesses enjoy higher revenues and profits. This enables companies not only to upgrade their plant and equipment assets, but also to hire new employees.

During a period of expansionary monetary policy, unemployment falls because companies find it easier to borrow money to expand their operations.

As more people find work, they have more money to spend, which increases income for businesses, thus creating more jobs.

Price stability

Inflation can be the result of expansionary monetary policy if the economy is too robust and too much money is generated.

Many people incorrectly believe that inflation comes from high prices. In fact, inflation occurs when there is so much money chasing available goods and services that money loses its value relative to the products it buys.

This results in higher prices for the scarce products. Buyers actually compete to buy them, thus obtaining a higher price.

Disadvantages

Considerations

The low interest rates paid by banks on your savings accounts make saving money less attractive, because the interest you earn is minimal.

Expansive monetary policy works because people and businesses tend to seek better returns by spending their money on equipment, new homes, new cars, investing in local businesses and other expenses, which promote the movement of money throughout the system, increasing activity. economical.

Why Expansive Monetary Policy May Not Work

Cutting interest rates is not guaranteed to cause a strong economic recovery. Expansive monetary policy can fail under certain conditions.

- If confidence is very low, then people may not want to invest or spend, even though interest rates are lower.

- In a credit crisis, banks may not have funds to lend; therefore, even if the central bank cuts base rates, it may still be difficult to obtain a bank loan.

References

1. Kimberly Amadeo (2018). Expansionary Monetary Policy. The Balance. Taken from: thebalance.com.
2. Financial Times (2018). Definition of expansionary monetary policy. Taken from: lexicon.ft.com.
3. Investopedia (2018). Expansionary Policy. Taken from: investopedia.com.
4. Tejvan Pettinger (2017). Expansionary Monetary Policy. Economics Help. Taken from: economicshelp.org.
5. Victoria Duff (2018). Goals of Expansionary Monetary Policy. Small Business - Chron. Taken from: smallbusiness.chron.com.