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What Is Expansionary Monetary Policy?

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  • Written By: Daniel Liden
  • Edited By: John Allen
  • Last Modified Date: 21 November 2016
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Monetary policy is a term used to refer to the control of the supply of money by a government or by whichever institution has authority over money in a given economic system. In an expansionary monetary policy, those with control over money attempt to increase the supply of money. Altering the money supply may alter interest rates, price levels, and other important economic factors. Different schools of economic though disagree on how expansionary monetary policy affects economic issues such as unemployment, income, and production. A variety of different economic tools exist to alter the money supply, including regulation of bank monetary reserves, alteration of interest rates, and increasing or decreasing money lending.

There are several different views on the effects that expansionary monetary policy has on the economy. The classical view of monetary policy, which is based on a quantity theory of money, states that there is a direct and strong correlation between money supply and price levels. Keynesian economic theory, however, supports the idea that there is only an indirect link between the two and that it may not be particularly useful. As such, Keynesian economists are more likely to use fiscal policy than monetary policy to cause economic change.

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Much of monetary policy is aimed at manipulating the supply of money relative to the demand for money. An expansionary monetary policy, then, often involves increasing the money supply until it is higher than demand. Assuming that there are no unexpected variables in the economy, this often leads to a widespread reduction in interest rates.

Banks are required to keep a certain amount of money in reserve, meaning that they cannot loan this money away. This policy is intended to ensure that banks will always have sufficient money on reserve to handle withdrawals. It also provides a tool for the manipulation of the money supply. In an expansionary monetary policy, the monetary authority may reduce this reserve requirement, thereby allowing banks to loan more money. This expansionary monetary policy introduces more money into the economy, thereby increasing the money supply.

The tools available for expansionary monetary policy vary based on the nature of a given economic system. Different central banks, finance ministries, or government departments have different levels of control over monetary policy. In the United States, for instance, the Federal Reserve has substantial power to enact expansionary monetary policy. It does so by setting some interest rates and by lending money to other banks within the United States.

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donasmrs
Post 3

@fBoyle-- Expansionary policies do more than affect inflation. Since these policies reduce interest rates and reduce the value of the dollar, they increase investment and increase exports.

It's easier to finance projects when interest rates are low. Also, American bonds in the exchange market will go up, so people will sell them, causing more US dollars to circulate. The value of US dollars will be lower so other countries will buy more American goods, while we will buy less goods from other countries.

So there is a whole set of chain reactions that will occur when a monetary policy to reduce interest rates is used.

discographer
Post 2

@fBoyle-- Expansionary monetary policies encourage or increase inflation because they increase supply. Increase in supply means that the value of money will increase. When the national currency loses value, prices will go up. All of this will translate as higher inflation.

You might be thinking that this is bad, but that's not necessarily true. If inflation was low and interest rates too high, this will be good for the economy. It will be stabilizing.

With expansionary monetary policy though, there is always a risk that the expansion will be too much. If inflation becomes too high and interest rates too low, then things will go in the opposite direction. The cost of living will be high and supply will be too great for demand. So a balance needs to be established.

fBoyle
Post 1

What is the effect of expansionary monetary policy on inflation?

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