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Encyclopedia > Expansionary monetary policy

Expansionary monetary policy is monetary policy that seeks to increase the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a finance ministry. Monetary policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth. ... The examples and perspective in this article or section may not represent a worldwide view. ... The finance minister is a cabinet position in a government. ...


Neoclassical and Keynesian economics significantly differ on the effects and effectiveness of monetary policy on influencing the real economy; there is no clear consensus on how monetary policy affects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates). Neoclassical economics refers to a general approach (a metatheory) to economics based on supply and demand which depends on individuals (or any economic agent) operating rationally, each seeking to maximize their individual utility or profit by making choices based on available information. ... Keynesian economics (pronounced ), also called Keynesianism, or Keynesian Theory, is an economic theory based on the ideas of 20th century British economist John Keynes. ...


Monetary policy relies on a number of tools: monetary base, reserve requirements, discount window lending and interest rates. The money base, or the monetary base is a government liability, currency and bank reserves. ... Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at the central bank (in the United States in a Federal Reserve Bank), rather than, perhaps, lend out. ... Discount window refers to the practice by a central bank of extending short-term loans secured by government bonds to financial institutions. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ...

Contents

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Policy Tools

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Monetary Base

Expansionary policy can be implemented by increasing the size of the monetary base. This directly increases the total amount of money circulating in the economy. In the United States, the Federal Reserve can use open market operations to increase the monetary base. The Federal Reserve would buy bonds in exchange for hard currency. When the Federal Reserve disburses this hard currency payment, it adds that amount of currency from the economy, thus increasing the monetary base. Note that open market operations are a relatively small part of the total volume in the bond market, thus the Federal Reserve is not able to influence interest rates through this method. The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... Open Market Operations are the means by which central banks control the liquidity of the national currency. ... Within finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon). ...

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Reserve Requirements

The monetary authority exerts regulatory control over banks. Expansionary policy can be implemented by allowing banks to hold a lower proportion of their total assets in reserve. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By requiring a lower proportion of total assets to be held as liquid cash the Federal Reserve increases the availability of loanable funds. This acts as an increase in the money supply.

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Discount Window Lending

Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. The lent funds represent an expansion in the monetary base. By extending new loans the monetary authority can directly increase the size of the money supply. By advertising that the discount window will increase future lending, the monetary authority can also indirectly increase the money supply by raising risk-taking by financial institutions.


After the September 11, 2001 attacks in the United States, the Federal Reserve announced that it would extend discount window loans to any and all financial institutions who requested funds. This had the effect of preventing any panics due to fear of insufficient liquidity. The September 11, 2001 attacks (often referred to as 9/11—pronounced nine eleven) consisted of a series of coordinated terrorist[1] suicide attacks upon the United States, predominantly targeting civilians, carried out on Tuesday, September 11, 2001. ...

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Interest Rates

Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can only indirectly set the Federal Funds Rate. This rate has some effect on other market interest rates, but there is no direct, definite relationship. In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By lowering the interest rate(s) under its control, a monetary authority can expand the money supply because lower interest rates discourage savings and encourage borrowing. Both results increase the size of the money supply. The federal funds rate is the interest rate at which depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight. ...

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Monetary Policy and the Real Economy

As noted above, the relationship between monetary policy and the real economy is uncertain. It is important to note that expansionary monetary policy should not be confused with economic expansion. The latter being an increase in economic output in the real economy.

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See also


  Results from FactBites:
 
Monetary policy - Wikipedia, the free encyclopedia (3387 words)
Monetary policy can involve setting interest rates, margin requirements, capitalization standards for banks or even acting as the lender of last resort or through negotiated agreements with other governments.
Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seniorage, or the power to coin.
Today this type of monetary policy is not used anywhere in the world, although a form of gold standard was used widely across the world prior to 1971.
RBA: Education-Monetary Policy (6804 words)
In these countries, monetary policy could be described as the management of short-term interest rates by central banks in pursuit of the domestic policy objectives, usually defined in terms of inflation and economic growth.
Monetary targeting was abandoned in Australia, and in most other countries, because it was found that the monetary aggregates were becoming increasingly unstable and unrelated to the variables of ultimate concern.
Monetary policy decisions always have to be made on the basis of imperfect information about economic prospects, and the money and credit aggregates represent part of the information (along with an array of other economic indicators) that can potentially help in making these assessments.
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