Expansionary Monetary Policy Vs Contractionary Monetary Policy
A monetary policy can either be contractionary or expansionary. The former accelerates economic growth while the latter restricts it. Conventionally, an expansionary policy is used to address issues of joblessness during depression by lowering the rate of interest with the hope easy credit will attract companies to expand. This is achieved by increasing money supply in an economy.
These policies are often used in accordance to the state of the economy at any given time and they both have some pros and cons. The contractionary policy is used to promote stable prices and reduce inflation. The process used to do this involves complex steps undertaken by the central bank which includes estimating the existing economic conditions and predicting what course the economy will take in the following years (preferably 2 years).
Once this is done, the central bank has to compare the results with its inflationary and economic growth goals. If the estimated inflation is more than the central banks goals, contractionary measures are employed. Some of the actions taken might include high short term interest rates and high reserve requirements which reduce the supply of money and slow down the pace at which an economy grows. The major disadvantage of this is the fact that companies and consumers find it difficult to get loans and what is more, it leads to increased cases of unemployment.
An expansionary monetary policy is the exact opposite and its effects are also different. The purpose of this policy is to expand the supply of money and at the same time, increase economic activity. This is achieved by keeping the interest rate low through addition of money into the system via open market. This is also carried out by the central bank and the goals of an expansionary monetary policy includes spurring economic growth, increasing employment opportunities and ensuring there is price stability.
A contractionary monetary policy has the exact opposite effects. Central banks have to be open and thorough when making a decision on which of these two policies to implement as they can have adverse effects on the economy. For instance, an expansionary policy has lagging effects which are noted between the time the policy is implemented and when the effects are felt. As such, it causes high cases of unemployment because businesses cannot expand.
Decisions on monetary policy take a long duration for them to be effect on the economy and especially in cases of a complex and large economy like that of the US. Therefore whether it is expansionary or contractionary policy, the effect exerted is not an immediate one.
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