Expansionary Monetary Policy

Definition

The term expansionary monetary policy refers to the process by which the central bank increases the money supply in order to stimulate economic growth. Expansionary policy is typically used to prevent or pull an economy out of a recession.

Explanation

Also known as easy monetary policy, expansionary monetary policy refers to a process whereby a country's central bank attempts to stimulate their economy. The principal tools of an expansionary policy in the United States include:

  • Money Supply: increasing the money supply through open market operations, whereby the central bank purchases Treasury notes from member banks, effectively increasing the supply of money.
  • Federal Funds: the federal funds rate is the interest rate charged banks for overnight deposits. Lowering the fed funds rate makes it less expensive for banks to borrow from other banks to maintain their reserve requirement, thereby encouraging additional lending by lowering the interest rates charged their customers.
  • Discount Rate: the central bank can also lower what's referred to as the discount rate. The discount rate is oftentimes lowered when the Federal Funds rate is lowered. Banks will only borrow from the central bank when no other lending institution will provide them funds.

All three of the above tactics encourage spending, thereby increasing the growth of an economy. When an expansionary monetary policy is in place, the central bank must ensure the economy doesn't grow too rapidly, resulting in a higher than desired level of inflation.

Related Terms

open market operations, reserve requirement, monetary policy, contractionary monetary policy, Federal Funds rate, fiscal policy