Question

On June 5, 2014 the European Central Bank acted to decrease the short-term interest rate in Europe. The following is from an article by the BBC:

The European Central Bank has introduced a raft of measures aimed at stimulating the eurozone economy, including negative interest rates and cheap long-term loans to banks.

It cut its deposit rate for banks from zero to -0.1%... The ECB is the first major central bank to introduce negative interest rates.

1. Would this move increase or decrease the money supply – what makes you think so? Which way would the money supply curve move

Answer 1

Expansionary monetary policy seeks to foster economic growth / combat inflationary price escalations by expanding the supply of money quicker than usual or lowering short run interest rates. Its enacted by central banks and comes about thru open market operations, reserve requirements & fixing rates of interest.

Expansionary monetary policy differs from fiscal policy, which comprises tax cuts, transfer payments & augmented governmental spending on projects like infrastructure improvements.

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

Expansionary policy is a helpful instrument for managing recession in the business cycle, but there are some risks. Economists must know when to enlarge the supply of money to prevent causing side effects, like high inflation.