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Formative Work For Macroeconomics Essay

1079 words - 5 pages

Monetary expansion is a macroeconomic policy which seeks to expand the money supply to encourage economic growth and combat inflation. One form of expansionary policy is monetary policy which is maintained through increasing interest rates or changing the amount of money banks need to keep in the vault. Expansionary policies can also come from central banks, which focus on increasing the money supply in the economy.

The effect of an expansionary monetary policy is to lower the exchange rate, weaken the financial account and strengthen the current account.
During recession there is a decline in activity across the economy. It is visible in industrial production, employment and real income. ...view middle of the document...

When the federal fund’s interest rate is decreased, the demand and the price of loans falls. Since the interest rate is the equilibrium factor in the market for loanable funds, a fall in the demand for loans results in a fall in the interest rate. This works in conjunction with a direct decrease in the interest rate affected by the Central Bank. This decrease in the interest rates can be displayed in a Money Supply/Money Demand diagram (Diagram A). The increase in nominal money shifts the money supply curve to the right (Mso-Ms1) therefore causing a lower equilibrium interest rate.
As monetary expansion decreases interest rates, this means the value of money will decrease. Lower interest rates means it is less expensive for firms to borrow money to invest in new production. This will increase aggregate supply meaning output will increase whilst price levels decrease.

When the central bank’s trading desk buys bonds and expands the money supply, it lowers interest rates and encourages the private sector to borrow and spend more. The influence of interest rates is particularly strong in housing where buyers are rate sensitive. Lower interest rates make fixed income investments less attractive so investors turn to the equity market and bid up stock prices. Higher stock prices in turn make consumers wealthier and more eager to spend. They also make it easier for corporations to expand their businesses with equity financing thus increasing output.

An increase in nominal money stock leads to a higher real money stock at each level of prices. The decrease in interest rates induces the public to higher real balances. It stimulates the aggregate demand and thereby increases the equilibrium level of income and spending as seen in Diagram B where thee demand curve shifts to the right.

In accordance to the aggregate demand/aggregate supply model, monetary expansion’s effect on price level is regarded as indeterminate. As monetary expansion will put more money into circulation, a portion of this money will be used by consumers to purchase goods and services produced in the economy. This increase in aggregate demand will causes general prices to increase hence increasing a businesses’ potential profit. A business will therefore...

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