Question

Define and contrast contractionary monetary policy and expansionary monetary policy and their respective economic outcomes (include changes in equilibrium interest rates). Explain what happens if the affects of either of these policies goes too far.

Answer 1

expansionary monetary policy and contractionary monetary policy are two opposite forces of monetary policy. expansionary moneary policy increases money supply in the economy via decreasing the interest rate while on the other hand contractionary monetary policy decreases the money supply in the economy via increasing the interest rate and increasing repo, revers repo, discount rate etc. in case of expansionary monetary policy moneysupply increases and rate of interest decline which promotes investment and increases employment and total output in the economy. if the policy continues then there are chances that the economy will face hyper inflation in the longrun. if contractionary monetary policy continues to work then the moneysupply will decrease and rate of interest will increase, investment will decline and the employment rate as well will decline. in the long run there are chances that a country will face recessionary situation in the worst case there are also chances of depression.