Principle of Macroeconomics

Posted: October 17th, 2013

Principle of Macroeconomics

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Principle of Macroeconomics

Expansionary monetary policy is where the government uses a combination of open market operations, federal discount rate and reserve requirements to increase the money supply, by lowering them (Moffatt, 2012). On the other hand, contractionary is the opposite of expansionary where the government uses the same tools to reduce the supply of money in the economy (Amadeo, 2012). In the table, ‘A represents discount rates of the federal bank, while ‘B’ represents the open market operations of the federal bank meant to control money supply. ‘C’ represents a lowered reserve requirements, which is used by the Federal Reserve to increase the supply of money. When the reserve requirements are lowered, the banks will have more money to their disposal for investment, hence the money supply increases. ‘D’ represents an increase in the money supply, so the arrow is facing upwards since the federal discount rate, which is an interest rate, has gone down, meaning lowered interests will leave banks with more money to invest or supply. ‘E’ on the other hand represents the opposite of expansionary, where the discount rates are increased. Therefore, the arrow in E will be pointing upwards. ‘F’ represents an upward arrow, since the money supply indicates a drop meaning that Federal Reserve requirements were increased, which left financial institutions with reduced supply of money. ‘G’ on the other hand represents selling of government bonds by the federal government, which causes an increase in interests indirectly. ‘H’ is a downward arrow, representing reduced money supply due to increased federal discount rates (Moffatt, 2012).

References

Amadeo, K. (2012). Contractionary Monetary Policy. Retrieved from: http://useconomy.about.com/od/glossary/g/Contractionary.htm

Moffatt, M. (2012). What Effects Does Monetary Policy Have: Expansionary Monetary Policy vs. Contractionary Monetary Policy. Retrieved from: http://economics.about.com/cs/money/a/policy_2.htm