expansionary vs contractionary monetary policy

1. Goal

• Expansionary Monetary Policy: Aims to stimulate economic growth during periods of slow growth or recession.

• Contractionary Monetary Policy: Aims to reduce inflation or cool down an overheated economy.

2. Actions Taken by Central Bank

• Expansionary:

  • Lower interest rates to make borrowing cheaper.

  • Increase the money supply through measures like purchasing government bonds.

  • Lower reserve requirements for banks, allowing them to lend more.

• Contractionary:

  • Raise interest rates to make borrowing more expensive.

  • Decrease the money supply by selling government bonds.

  • Increase reserve requirements, limiting the amount banks can lend.

3. Effects on the Economy

• Expansionary:

  • Encourages borrowing and spending by households and businesses.

  • Boosts consumption, investment, and aggregate demand.

  • Leads to economic growth, potentially increasing employment.

• Contractionary:

  • Discourages borrowing and slows down spending.

  • Reduces consumption and investment, lowering aggregate demand.

  • Helps control inflation but can slow economic growth and increase unemployment.

4. Risks

• Expansionary:

  • Can lead to high inflation if demand grows too quickly.

  • May cause currency depreciation, making imports more expensive.

• Contractionary:

  • Can lead to economic slowdown or even recession if applied too aggressively.

  • May increase unemployment as businesses scale back operations.