Expansionary Monetary Policy

Expansionary monetary policy is a form of economic policy that involves increasing the money supply so as to decrease the cost of borrowing which in turn increases growth rate and reduces unemployment rate. Expansionary monetary policy is used to fight off recessionary pressures.

Expansionary monetary policy is implemented by the central banks (in US, the Fed). When the economy is in recession, the central bank increases the money supply by a combination of decrease in discount rate, purchase of government bonds and reduction in the required reserve ratio. The increase in money supply relative to demand decreases the cost of borrowing and increases consumption and investment which in turn increases GDP.

Example

James Traina works as Assistant Economist at World Bank. He is developing policy recommendations for Estovakia and Estrovia. Estovakia has unemployment rate of 7% as compared to natural unemployment rate of 3%, inflation rate of -1% and a growth rate of 0.5% as compared to average of 4%. Estrovia has unemployment rate of 1% as compared to natural unemployment rate of 3%, inflation rate of 9% as compared to average of 4% and a growth rate of 7% as compared to average of 3.5%. For which country James would most likely recommend an expansionary monetary policy?

Expansionary monetary policy is a remedy for high unemployment rate, very low inflation rate and low growth rate. Since Estovakia has unemployment rate of 7% as compared to natural rate of 3%, inflation rate of -1% and a growth rate of 0.5% as compared to historical average of 4%, it is a good candidate for expansionary monetary policy.

Written by Obaidullah Jan