What is an ‘Expansionary Policy’
An expansionary is a macroeconomic policy that seeks to encourage economic growth or combat inflationary price increases by expanding the money supply , lowering interest rates, increasing government spending or cutting taxes. One form of expansionary policy is fiscal policy , which comes in the form of tax cuts, transfer payments, rebates and increased government spending on projects such as infrastructure improvements. Another form is monetary policy, which is enacted by central banks and comes about through open market operations, reserve requirements and setting interest rates.
The most common form of expansionary policy is through the implementation of monetary policy. The U.S. Federal Reserve employs expansionary policies whenever it lowers the benchmark federal funds rate or discount rate, decreases required reserves for banks or buys Treasury bonds on the open market . Quantitative easing, or QE, is another form of expansionary monetary policy.
Open Market Operations – OMO
Accommodative Monetary Policy
BREAKING DOWN ‘Expansionary Policy’
For example, when the benchmark federal funds rate is lowered, the cost of borrowing from the central bank decreases, giving banks greater access to cash that can be lent in the market. When reserve requirements decline, it allows banks to lend a higher proportion of their capital to consumers and businesses. When the government purchases debt instruments, it injects capital directly into the economy.
From a fiscal perspective, the government enacts expansionary policies through budgeting tools that provide people with more money. For example, it can increase discretionary government spending, infusing the economy with more money through government contracts. Additionally, it can cut taxes and leave a greater amount of money in the hands of the people who then go on to spend and invest.
The Risks of Expansionary Monetary Policy
Expansionary policy is a useful tool for managing low-growth periods in the business cycle, but it also comes with risks. Economists must know when to expand the money supply to avoid causing side effects, such as high inflation. There is also a time lag between when a policy move is made and when it works its way through the economy. This makes up-to-the-minute analysis nearly impossible, even for the most seasoned economists. Prudent central bankers and legislators must know when to halt money supply growth or even reverse course and switch to a contractionary policy , which would involve taking the opposite steps of expansionary policy, such as raising interest rates.
An Example of Expansionary Policy
Declining oil prices from 2014 through the second quarter of 2016 caused many economies to slow down. Canada was hit specifically hard in the first half of 2016, with almost one-third of its entire economy based in the energy sector. This has caused bank profits to decline, making Canadian banks vulnerable to a recession. To combat these low oil prices, Canada was expected to enact an expansionary monetary policy by reducing interest rates within the country. The expansionary policy was targeted to boost economic growth domestically. However, the policy could also have meant a decrease in net interest margins for Canadian banks, squeezing bank profits.
Another example is the policy following the 2008 financial crisis , where central banks around the world lowered interest rates to near zero, and performed other measures such as multiple rounds of quantitative easing. This helped keep the Great Recession from turning into a full-blown economic depression and helped along the albeit slow recovery that followed.
Monetary PolicyMonetary policy: Actions of a central bank or other committees …
Open Market Operations – OMOOpen market operations refer to the buying and selling of government …
Contractionary PolicyA contractionary policy is a macroeconomic tool used by a countrys …
Accommodative Monetary PolicyAccommodative monetary policy occurs when a central bank attempts …
Easy MoneyEasy money is when the Federal Reserve allows cash flow to build …
Quantitative EasingQuantitative easing is a monetary policy in which a central bank …
Fiscal Policy vs. Monetary Policy: Pros & ConsWhen it comes to influencing macroeconomic outcomes, governments have typically relied on one of two courses of action: monetary policy or fiscal policy.
4 Economic Indicators That Move Financial StocksFind out about some of the most important macroeconomic indicators that investors in the financial services sector should watch out for when trading stock.
Chicago PMI Misses, Falls Back Into ContractionISMs Chicago PMI disappointed analysts, who expected it to remain in expansionary territory. The index has been see-sawing all year, and investors are looking
How Monetary Policy Impacts Income InequalityIncome inequality is growing. Does monetary policy have a critical impact on its widening gap?
Why Negative Interest Rates Are Not WorkingFind out why negative interest rate policies are failing because bond buyers do not want a negative yield and saturated borrowers want to pay off debts.
How Negative Interest Rates Can Affect CurrenciesAnalyze the relationship between interest rates and currency devaluation. Examine the impact of negative rates and how further declines could affect currencies.
Why the Stock Market Isnt Affected by Slow GDP GrowthLearn how the stock market reached new levels in the years following the financial crisis, even though U.S. economic conditions were consistently weak.
How the Federal Reserve Devises Monetary PolicyLearn about the tools the Federal Reserve uses to influence interest rates and economic conditions. Find out the types of action a central bank may take.
How does fiscal policy impact the budget deficit?
Fiscal policy refers to any uses of the government budget to affect the economy including government spending and levied … Read Answer >>
What are some examples of expansionary fiscal policy?
Learn about expansionary fiscal policy – tax cuts and government spending – that are used by governments to boost spending … Read Answer >>
Monetary policy vs. Fiscal policy
What is the difference between monetary policy and fiscal policy? Check out how government use these two policy tools to … Read Answer >>
What are the implications of a low federal funds rate?
Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact … Read Answer >>
How are interest rates related to open market operations?
Learn about open market operations and how this monetary policy tool impacts interest rates. Find out how the Fed combats … Read Answer >>
How can a change in fiscal policy have a multiplier effect on the economy?
A change in fiscal policy has a multiplier effect on the economy because fiscal policy affects spending, consumption, and … Read Answer >>