Expansionary Monetary Policy
To increase the money supply, the Central Bank can
- buy government bonds (an open market purchase)
- lower the discount rate
- lower the reserve ratio
Expansionary monetary policy is appropriate when the economy is in a recession and unemployment is a problem.
Changes in the money supply affect the economy through a 3 step process.
- an increase in the money supply causes interest rates to fall
- the decrease in interest rates causes consumption and investment spending to rise and so aggregate demand rises
- the increase in aggregate demand causes real GDP to rise
Contractionary Monetary Policy
To decrease the money supply, the Central Bank can
- sell government bonds (an open market sale)
- raise the discount rate
- raise the reserve ratio
Contractionary monetary policy is appropriate when inflation is a problem.
- a decrease in the money supply causes interest rates to rise
- the increase in interest rates causes consumption and investment spending to fall and so aggregate demand falls
- the decrease in aggregate demand causes real GDP to fall
