Which Monetary Policy Is Better for Our Economy Expansionary or Contractionary Monetary Policy

When this happens, a central bank will try to increase the money supply, which will make it easier to borrow and issue. And it uses the same monetary tools, but in the opposite way. Under the Directive, investors are aware of the central bank`s inflation target and can therefore more easily take into account likely changes in interest rates in their investment decisions. Inflation targets see it as a consequence of increased economic stability. Total Demand Chart: This chart shows the impact of expansionary monetary policy by moving aggregate demand (DA) to the right. When the economy is suffering from recession and high unemployment, and output is below GDP potential, an expansionary monetary policy can help the economy return to potential GDP. Figure 2(a) illustrates this situation. This example uses a short-run ascending Keynesian aggregate supply curve (SARS). The initial equilibrium during an E0 recession occurs at a production level of 600. Expansionary monetary policy will lower interest rates and stimulate investment and consumer spending, resulting in the shift of the initial aggregate demand curve (AD0) to the right towards AD1, so that the new equilibrium (E1) occurs at the potential GDP level of 700. A central bank can conduct expansionary monetary policy in several ways.

The most important means a central bank uses to implement expansionary monetary policy is by opening markets. In general, the central bank buys government bonds, which lowers interest rates. Purchases not only increase the money supply, but also promote investment through their impact on interest rates. “The Fed`s power comes primarily from its authority over these two important aspects of the economy,” says Robert Johnson, a professor of finance at Creighton University. “The Fed is implementing these goals through its power to control the money supply.” He was given these responsibilities in 1977 by a dual congressional mandate, and he can use a handful of tools to implement his powers. We can compare the discount rate (policy interest rate) with the neutral interest rate. If the discount rate is higher than the neutral interest rate, monetary policy can be said to be contractionary and vice versa. This means that the central bank is trying to reduce the money supply. Of course, financial markets have a wide range of interest rates that represent borrowers with different risk premiums and loans to repay over different periods of time. In general, when the federal funds rate falls significantly, other interest rates also fall, and when the federal funds rate rises, other interest rates rise.

However, a one-percentage-point drop or increase in the federal funds rate — which is intended for overnight borrowing — typically has less than one percentage point of impact on a 30-year loan to buy a home or a three-year loan to buy a car. Monetary policy can push the entire spectrum of interest rates up or down, but specific interest rates are set by the forces of supply and demand in these specific markets for lending and borrowing. Central banks use monetary policy to control the money supply in a country`s economy. With monetary policy, a central bank increases or decreases the amount of liquidity and credit in circulation to keep inflation, growth and employment on track. Monetary policy is the process by which a country`s monetary authority controls the money supply to promote stable employment, prices and economic growth. Monetary policy can influence an economy, but it cannot control it directly. There are limits to what monetary policy can do. Here are some of the factors that can make monetary policy less effective. These examples suggest that monetary policy should be counter-cyclical; That is, it should act to balance the economic cycles of economic downturns and recoveries. Monetary policy should be eased when a recession has led to an increase in unemployment and tightened when inflation threatens. Of course, there is a risk of overreaction. If a loose monetary policy that seeks to end a recession goes too far, it can push aggregate demand so far to the right that it triggers inflation.

If a restrictive monetary policy aimed at reducing inflation goes too far, it could push aggregate demand so far to the left that a recession begins. Figure 3(a) summarizes the chain of effects that combine loose and restrictive monetary policy with changes in output and price levels. Open market operations. The Fed buys and sells government bonds such as Treasuries and bonds on the open market. By buying back securities, the Fed effectively increases the money supply – conversely, the sale of securities reduces supply. In the past, open market operations have been the most commonly used instrument for conducting monetary policy. .