Monetary Policy Expansion: Fueling Growth with Lower Interest Rates - Aims, Strategies, Outcomes
In an effort to boost household consumption and business investment, the United States Federal Reserve (the Fed) implemented an expansionary monetary policy in 2020. This policy, aimed at increasing the economy's money supply to stimulate growth, was a response to the economic challenges posed by the global pandemic.
At the heart of this policy is the Federal Reserve's lowering of the fed fund rate by 100 basis points to 0.25%. This move, along with other measures, was designed to increase liquidity and lower lending rates, encouraging households to increase consumption and businesses to invest in capital goods.
An expansionary monetary policy works by weakening the price of the domestic currency against foreign currencies, a process known as depreciation. This depreciation encourages exports and discourages imports, stimulating domestic economic growth.
However, the central bank must be careful not to adopt an overly aggressive expansionary monetary policy to avoid high inflationary pressure. Under the quantitative theory of money, economists relate the money supply, the velocity of money, the price level (inflation), and aggregate output into the equation M x V = P x Y.
Central banks can implement expansionary policies by cutting policy rates, lowering the reserve requirement ratio, or purchasing government securities. In the case of the Fed, lowering the reserve requirement ratio allowed commercial banks to use more of their deposits for lending, increasing the money supply.
Under expansionary monetary policy, the central bank buys government securities from commercial banks, increasing the money supply and lowering lending rates. This, in turn, leads to a decrease in interest rates and borrowing costs, stimulating household spending, especially on durable goods like property and cars.
The increased liquidity and lower lending rates also encourage businesses to find investment costs cheaper, leading to an increase in production. This, coupled with higher household consumption and business investment, helps the economy move out of recession and head for an expansion path.
It's important to note that in the short run, an increase in the money supply can lead to an increase in the inflation rate. However, as the economy expands and output increases, the pressure on prices may ease.
In addition, the unemployment rate may still be high at the beginning of the implementation of expansionary monetary policy. However, as demand and profit prospects improve, businesses will increase output through investment in capital goods and recruitment of workers, leading to a decrease in the unemployment rate.
Commercial banks borrow money from central banks to meet liquidity shortages, and changes in policy interest rates affect bank behavior in making loans. This, in turn, influences the overall economy, making monetary policy a powerful tool in managing economic cycles.
GDP can be calculated using the expenditure approach, with exports and imports playing a significant role in its calculation. The expansionary monetary policy encourages an increase in aggregate demand, stimulating businesses to increase production and recruit more workers, contributing positively to the GDP.
In conclusion, the expansionary monetary policy implemented by the Fed in 2020 was a strategic move to stimulate economic growth by increasing the money supply and lowering interest rates. While it comes with potential risks, such as inflation, the benefits of increased household consumption, business investment, and economic growth make it a valuable tool in the central bank's arsenal.
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