Define Central bank: the official bank of the country. It is the head of all commercial banks and
is in charge of conducting monetary policies.
Define expansionary monetary policy: expansionary monetary policy is a demand side policy
where the central bank decreases interest rates and increases money supply to prompt an
increase in aggregate demand.
When conducting monetary policy, the central bank has several tools that can be used. These
include: interest rates and capital reserves.
Interest rates are the cost of borrowing and the reward for saving.
Graph (outwards shift in AD)
Decreasing interest rates means that the reward for saving decreases so marginal propensity to
save decreasess. At the same time, a decrease in interest rates means that loans are more
affordable., as a result marginal propensity to consume increases.
Moreover, FIGURE 2 shows the inverse relationship between interest rates and investment.
Given that consumption and investment increase. And that these two are components of
aggregate demand, an increase in these results in an increase in AD.
Mimum reserves ratio refers to the amount of money commercial banks need to have in their
reserve. It is expressed as a percentage of the total money they receive. A decrease in the cash
ratio results in more loans available, hence increased credit and money supply.
As more people can have access to loans there is increased consumption and investment which
again shift aggregate demand as shown in figure 1.
B)
Monetary policy is a demand side policy conducted by the central bank which works in
changing interest rates and adjusting money supply to achieve macroeconomic aims. Monetary
policy can be expansionary or contractionary depending on what the state of the economy is
and what is the objective of the central bank. In the case that they want to achieve low
unemployment which is a macroeconomic aims that refers to maintaining a low level of
members of the labour force that are actively (capable and willing to work) but cannot find a
job. The government wants a low level of unemployment because unemployment leads to
decreased living standards for the population, more inequality among the country and
decreased allocative efficiency as not all resources are being employed.
To achieve low unemplopyment expansionary moentary policy would be conducted.
Graph of ad shifting
Ways to increase money supply:
Open market operations, quantitative easing, decreasing interest rates and decreasing the
minimum reserve ratio as already mentioned in part a.
For example, if USA struggling to reactivate the economy amid a recessionary gap caused by the
pandemic would employ expansionary monetary policy by decreasing interest rates they could
increase investment.
GRAPH OF INVESTMENT (reference to part a)
As investment increases, the economy expands and firms grow, hence employing more
workers. Demand for labour increases (graph of demand for labour)
Another opportunity where expansionary monetary policy could be employed is buying
securities as a form of open market operations to increase money supply in the economy. As
more money is going around the economy, consumption increased. The increase in demand
makes the firms employ more workers to cover that extra demand. Hence, increased demand
for employment.
Evidently, in both cases expansioinary monetary policy can lead to an increase in employment.
An increase in employment as a result leads to increased living standards and economic growth
of the country as a result of increased output.
However, this policy has its limitations:
- Spend money buying security bonds
- Low interest rates discourage foreign direct investment
- Can lead to inflation (too much increased money supply)
Moreover, there are alternative measures the government can take that can probably be a
better alternative. For example, expansionary fiscal policy. The government could increase
investment and this would be specially effective if the country is in a deep recession. Increasing
government spending can really help reactivate the eoconomy. Moreover another advantage is
that it can be targeted to specific sectors. It would be important to look into the country’s
unemployment and identify what is causing it. Is it frictional, seasonal, structural or cyclical
unemployment? If it is high seasonal unemployment of farmers for example, the government
can direct spending to subsidizing local farmers so that they can grow a variety of crops and
work all year round. Or for example, if the cause of unemployment is that tha lebaour force is
unskilled, the government spending can be directed to seminars and learning opportunities to
increase the skills of the labour force and make them more qualified.