Question

In: Economics

Does expansionary monetary policy impact the federal budget? Briefly explain why or why not.

Does expansionary monetary policy impact the federal budget? Briefly explain why or why not.

Solutions

Expert Solution

Expansionary monetary policy Lower interest rates make it cheaper to borrow; this encourages firms to invest and consumers to spend.
Lower interest rates reduce the cost of mortgage interest repayments. This gives households greater disposable income and encourages spending.
Lower interest rates reduce the incentive to save.
Lower interest rates reduce the value of the Pound, making exports cheaper and increase export demand.


Cutting interest rates isn’t guaranteed to cause a strong economic recovery. Expansionary monetary policy may fail under certain conditions.

If confidence is very low, then people may not want to invest or spend, despite lower interest rates.
In a credit crunch, banks may not have funds to lend, therefore although the Central Bank cuts base rates, it is still difficult to get a loan from a bank.
Commercial banks may not pass the base rate cut on.When business loans are more affordable, companies can expand to keep up with consumer demand. They hire more workers, whose incomes rise, allowing them to shop even more. That's usually enough to stimulate demand and drive economic growth to a healthy 2-3 percent rate.


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