Question

Discuss the consequences of applying an expansionary monetary policy in a country

Answer 1

Expansionary monetary policy aims to increase economic aggregate demand and economic growth.
Expansionary monetary policy involves cutting interest rates or increasing the supply of money to stimulate economic activity.

Lower interest rates make borrowing cheaper; this encourages companies to invest, and consumers to spend. Lower interest rates reduce the costs of repaying interest on mortgages. It gives households more discretionary resources and encourages spending. Lower interest rates lower the incentive for saving. Lower interest rates are reducing the Pound value, making exports cheaper, and rising export demand.

In addition to cutting interest rates, the central bank may follow a program of quantitative easing to increase the money supply and lower long-term interest rates. Then, it uses this created money to buy commercial banks government bonds. That should, in principle, be: Increase banks' monetary base and cash reserves which will allow for higher loans. Reduce bond interest rates which should assist investment.

Expansionary policies seek to promote the growth of aggregate demand. Aggregate demand, as you may recall, is the sum of private consumption , investment , government spending and imports. The first two elements are focused on monetary policy. The central bank promotes private spending by rising the amount of money inside the economy. Increasing the money supply also decreases the interest rate, which encourages lending and investment. The rise in consumption and expenditure contributes to increased aggregate demand.

It's important to make credible announcements for policy makers. If private agents (consumers and firms) agree that policymakers are committed to economic development, the agents will expect higher future prices than they would otherwise be. Then the private agents will adjust their long-term plans accordingly, for example by taking out loans to invest in their business. But if the agents think the actions of the central bank are short-term, they will not alter their actions and mitigate the impact of the expansionary policy.