Question

When an economy is in a recession, the Fed needs to do a (an) ________ monetary policy. This policy would ________ prices.

A) expansionary; lower

B) expansionary; raise

C) contractionary; lower

D) contractionary; raise

Answer 1

Answer :B

Expansionary monetary policy increases money supply. Few examples of expansionary monetary policies purchasing government securities, reducing reserve ratio , change in bank rate etc. With expansionary monetary policy, money supply increases in the economy. When central bank reduces reserve ratio, banks het hold of more money to lend, which cause aggregate demand curve shift upward. New aggregate demand curve intersect agregate supply curve at a higher level of output. Thus an expansionary monetary policy boost economic growth and economy recedes from recession.

When money supply increases, interest rate decreases which induce investors in invest more. An increase in investment leads increase in output and employment.

As per quantity theory of money, When money supply increases prices also increase in same proportion. Thus with expansionary monetary policy, inflation occurs as result of increase in money supply.