Module 12 and 13

Running head: MODULE 12 1

MODULE 12 4

Module 12

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Instructions

Explain the use of the tools of monetary policy in constructing an expansionary policy and describe under what economic conditions you think it should be employed? What will the desired outcomes be?

Answer the same questions with regard to a tight or contractionary money policy. Which do you feel is more effective an expansionary or contractionary policies? Explain.

Monetary policy refers to how money supply and interest rates are controlled by the central bank to influence employment, prices, and output (Chappelow, 2019). The monetary policy tools used are open market operations, bank reserve requirement, direct lending to the banks, the management of market expectations, and unconventional emergency programs of lending.

In open market operations, the short-term bonds are purchased and sold on the open market. This operations target the short-term interest rates for instance, federal funds rate. Money is added into the banking system by purchasing the assets or eliminates it by selling the assets. On the other hand, the banks extend the loan at lower rates or at higher rates, until the targeted rate is attained (Chappelow, 2019). In addition, open operations can target certain increases in money supply to enable ease in offering loans by implementing quantitative easing.

Reserve requirement mandates banks to retain some amount of money with the central bank and is based on customer deposit. This ensures that banks have the ability to honor their liabilities (Chappelow, 2019). Banks have more capital for lending or purchasing assets when the reserve requirement is lowered and vice versa.

In direct lending, the interest rates and or the needed collateral demanded by the central bank to get an emergency loan to execute its role as last resort lender are changed. This rate is regarded as discount rate. A contractionary policy illustration is the charging of higher rates and asking for more collateral which makes banks to be careful with lending (Chappelow, 2019). Riskier loans take toll when the rates are lowered and security regiments loosened which is expansionary.

Unconventional policy was used recent recession (Chappelow, 2019). The Fed introduced programs to purchase assets and new lending which combined quantitative easing, open operations, and discount lending leading to economic recovery.

The central banks make announcements about own policies in the future to shape market expectations. By remaining open and predictable, the objective shaping and stabilizing expectations to control the volatile swings of the market because of the unexpected policy changes (Chappelow, 2019). Others can decide to remain opaque to the market participants due to the perception of maximizing monetary policy changes in an effective way by ensuring that they cannot be predicted.

An expansionary monetary policy is more effective compared to a contractionary policy. During periods of high unemployment as in a recession, an expansionary policy is used by the monetary authority to expand economic activity and increase economic growth. An expansionary policy can be lowering the interest rates which, in turn discourages saving and enhances spending. This ensures that more money flows to the market, hoping to increase consumer spending and investment. Lower rates imply that loans can be borrowed to spend on consumer good and expand production. In the recent recession, the expansionary used was low to zero interest rates. Increased money supply can however, result in hyper inflation, increasing the business and living cost. This inflation can be brought down by employing contractionary monetary policy such as increasing the interest rates and reducing money supply growth (Chappelow, 2019). Consequently, unemployment can go up and economic growth slowed down. It is however, needed to control inflation. The inflation rate was higher in the early 1980s at an estimate of 15%. The rate of interest was increased to 20%. The inflation was reduced to around 3%. A recession was felt though.

Reference

Chappelow, J. (2019). Monetary policy. Retrieved from https://www.investopedia.com/terms/m/monetarypolicy.asp