Expansionary monetary policy
Encyclopedia
In economics, expansionary policies are fiscal policies, like higher spending and tax cuts, that encourage economic growth. In turn, an expansionary monetary policy is monetary policy
that seeks to increase the size of the money supply
. In most nations, monetary policy is controlled by either a central bank
or a finance ministry.
Neoclassical
and Keynesian economics
significantly differ on the effects and effectiveness of monetary policy on influencing the real economy; there is no clear consensus on how monetary policy affects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates).
Monetary policy relies on a number of tools: monetary base
, reserve requirement
s, discount window lending
and interest rate
s.
. This acts as an increase in the money supply.
After the September 11, 2001 attacks
in the United States, the Federal Reserve announced that it would extend discount window loans to any and all financial institutions who requested funds. This had the effect of preventing any panics due to fear of insufficient liquidity.
Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate
, as well as achieve the desired federal funds rate
by open market operations. These rates have significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market.
In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By decreasing the interest rate(s) under its control, a monetary authority can expand the money supply
, because lower interest rates discourage savings and encourage lending. Both of these effects increase the size of the money supply.
(expansionary monetary policy should not be confused with economic expansion, which is
an increase in economic output in the real economy).
Any change to the real economy resulting from an expansionary monetary policy is subject to
time lags and effects from other economic variables; in addition, there are possible side
effects of expansion, including inflation.Recall the ways that the Fed implements expansionary monetary policy. A lower required reserve ratio provides more funds for banks to lend to their customers. If the Fed decides to buy Treasury securities, the supply of loanable funds and the banks’ reserves increase. Finally, banks find it easier to borrow from the Fed and increase their reserves when the discount rate is lower. Expansionary monetary policy shifts the aggregate demand AD curve outward.
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
that seeks to increase the size of the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
. In most nations, monetary policy is controlled by either a central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
or a finance ministry.
Neoclassical
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
and Keynesian economics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
significantly differ on the effects and effectiveness of monetary policy on influencing the real economy; there is no clear consensus on how monetary policy affects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates).
Monetary policy relies on a number of tools: monetary base
Monetary base
In economics, the monetary base is a term relating to the money supply , the amount of money in the economy...
, reserve requirement
Reserve requirement
The reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold of customer deposits and notes...
s, discount window lending
Discount window
The discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...
and interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
s.
Monetary base
Expansionary policy can be implemented by increasing the money supply relative to the quantity demanded - it will cause the equilibrium rate of interest to fall, all other things being equal.Reserve requirements
The monetary authority exerts regulatory control over banks. Expansionary policy can be implemented by allowing banks to hold a lower proportion of their total assets in reserve. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By requiring a lower proportion of total assets to be held as liquid cash the Federal Reserve increases the availability of loanable fundsLoanable funds
In economics, the loanable funds market is a hypothetical market that brings savers and borrowers together, also bringing together the money available in commercial banks and lending institutions available for firms and households to finance expenditures, either investments or consumption...
. This acts as an increase in the money supply.
Discount window lending
Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. The funds expands the monetary base. By extending new loans the monetary authority can directly increase the size of the money supply. By advertising that the discount window will increase future lending, the monetary authority can also indirectly increase the money supply by raising risk-taking by financial institutions.After the September 11, 2001 attacks
September 11, 2001 attacks
The September 11 attacks The September 11 attacks The September 11 attacks (also referred to as September 11, September 11th or 9/119/11 is pronounced "nine eleven". The slash is not part of the pronunciation...
in the United States, the Federal Reserve announced that it would extend discount window loans to any and all financial institutions who requested funds. This had the effect of preventing any panics due to fear of insufficient liquidity.
Interest rates
The expansion of the monetary supply can be achieved indirectly by decreasing the nominal interest rates.Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate
Discount rate
The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
, as well as achieve the desired federal funds rate
Federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
by open market operations. These rates have significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market.
In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By decreasing the interest rate(s) under its control, a monetary authority can expand the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
, because lower interest rates discourage savings and encourage lending. Both of these effects increase the size of the money supply.
Monetary policy and the real economy
As noted above, the relationship between monetary policy and the real economy is uncertain(expansionary monetary policy should not be confused with economic expansion, which is
an increase in economic output in the real economy).
Any change to the real economy resulting from an expansionary monetary policy is subject to
time lags and effects from other economic variables; in addition, there are possible side
effects of expansion, including inflation.Recall the ways that the Fed implements expansionary monetary policy. A lower required reserve ratio provides more funds for banks to lend to their customers. If the Fed decides to buy Treasury securities, the supply of loanable funds and the banks’ reserves increase. Finally, banks find it easier to borrow from the Fed and increase their reserves when the discount rate is lower. Expansionary monetary policy shifts the aggregate demand AD curve outward.