Question

3. How does the federal reserve (us central bank) conduct expansionary monetary policy? What tools do they control and what do they target? Under what circumstances will expansionary monetary policy be successful?

Answer 1

Expansionary monetary policy seeks to stimulate economic growth / combat inflationary price escalations by expanding the supply of money quicker than usual or lowering short run interest rates. It is enacted by the federal bank and comes about thru open market operations, reserve requirements & establishing interest rates.

The Federal Reserve uses an expansionary policy when it lessens the benchmark federal funds rate / the discount rate, lessens required reserves for financial institutions or purchases Treasury bonds  (open market operations). QE is also a kind of expansionary monetary policy.

For instance, if the benchmark federal funds rate is lessened, the cost of borrowing from the federal bank falls, providing the banks more access to cash which can be lent in the market. When reserve requirements fall, it enables the banks to lend a greater proportion of their capital to customers & firms. When the government buys debt instruments, it injects capital into the economy directly.

Expansionary monetary policy is successful if –

• If confidence is sufficiently high, then people may want to invest / spend.
• Banks should have sufficient funds to lend, when the Central Bank lessens base rates.
• Commercial banks must pass on the base rate cut .