Increasing Monetary Policy: Fueling Expansion with Reduced Rates

Increasing Monetary Policy: Fueling Expansion with Reduced Rates - Aim, Strategies, Consequences

The central bank, as the monetary authority of a country, plays a crucial role in managing the economy. One of the key tools at their disposal is monetary policy, which can be divided into two types: expansionary and contractionary.

Expansionary monetary policy is designed to stimulate economic growth by increasing the economy's money supply. This is achieved through several means. One such method is the lowering of the policy rate, as demonstrated by the Federal Reserve in March 2020 when they reduced the rate to 0.25%.

Another tool is the decrease in the reserve requirement ratio, allowing commercial banks to lend more money, thereby increasing the money supply and liquidity in the economy. This, in turn, lowers interest rates and borrowing costs, stimulating household spending, especially on durable goods like property and cars. Lower interest rates also encourage businesses to invest, initially in light equipment and later in heavier equipment for increased production.

The increased money supply and lower interest rates are not without their effects. They also lead to a weakened price of the domestic currency against foreign currencies, a phenomenon known as depreciation. While this may initially discourage imports, it also makes imported goods more expensive. However, depreciation can encourage exports and stimulate domestic economic growth as measured by real GDP growth.

Expansionary monetary policy also works through its influence on aggregate demand, which includes household consumption, business investment, government spending, and imports. By stimulating these components, the policy seeks to create a stronger aggregate demand, leading to economic growth.

It's important to note that while expansionary monetary policy can boost economic growth, it may also lead to increased inflation. This can be both favorable and unfavorable for the economy, as it can lead to higher prices for goods and services, but it can also erode the purchasing power of the currency.

As businesses find investment costs cheaper, they are slowly increasing production. This increased production activity leads to the recruitment of more workers, thereby decreasing the unemployment rate, which may still be high at the beginning of the implementation of expansionary monetary policy.

In conclusion, expansionary monetary policy is a powerful tool used by central banks to stimulate economic growth. By increasing the money supply and lowering interest rates, it aims to boost aggregate demand, leading to increased production, employment, and economic growth. However, it's crucial to understand that this policy also comes with potential risks, such as increased inflation.