Question

Explain the use of the tools of monetary policy in constructing an expansionary policy and describe under what economic conditions you think it should be employed? What will the desired outcomes be?

Answer the same questions with regard to a tight or contractionary money policy. Which do you feel is more effective an expansionary or contractionary policies? Explain.

Answer 1

The monetary policies are used to regulate the money market in an economy, hence when the money supply has to be either cut down or increased this particular tool is used to increase and decrease the money supply. For example, the use of open market operation. When the bank wants to increase or expanded it starts buying the security and government bonds. This will give the cash in the hands for a commercial bank to give out loans and hence there will money in the economy. It is mostly applied in situations where the consumption rate has fallen down extremely low that is resulting in the economy falling in demand in the market.

When the monetary policy is used to reduce the money supply in the market, then the contractionary policy is used, this results in lesser cash flow in the money market and thus result in lesser liquidity. In the same example mentioned above, if there was open market used to sell the security and government bonds, then this would lead to lesser mobility of cash and the commercial banks would find it difficult to give out loans.

At prima facie both look effective, however, controlling inflation in an economy is done through the contractionary policies. Inflation is an important aspect of any economy and it becomes important to control inflation. Hence, the contractionary policy becomes more effective.