CONCEPT – EXPANSIONARY AND CONTRACTIONARY POLICIES

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 CONCEPT – EXPANSIONARY AND CONTRACTIONARY POLICIES

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• What is monetary policy : The Monetary Policy comprises actions by the central banks to control and regulate the money supply to the public and a flow of credit, to ensure the stability in price and trust in the currency. This is done by targeting the inflation rate and the interest rate.
• Two types of Monetary Policy : We can have an expansionary or a contractionary monetary policy.

1. Expansionary Monetary Policy - It is adopted when the economy is in a recession, and unemployment or growth rate is the key problem. The expansion policy is undertaken with an aim to increase the aggregate demand by CUTTING THE INTEREST RATES and hence increasing the supply of money in the economy. Money supply can be increased by buying the government bonds, or by lowering the interest rates and the reserve ratios (CRR and SLR). By doing so, the consumer spending increases, the private sector borrowings increases, unemployment reduces and the overall economy grows. Expansionary policy is also called as “easy monetary policy”. 
2. Contractionary Monetary Policy - It is applied when HIGH INFLATION is a problem and economy needs to be slowed down a bit, by curtailing the supply of money. Inflation is characterized by increased money supply and increased consumer spending. Thus, a Contractionary policy is adopted with an aim to decrease the money supply and the spendings in the economy. This is done by INCREASING INTEREST RATES so that the borrowing becomes expensive. 

• Risks and other factors : Although an expansionary monetary policy is useful during the slow period in a business cycle, it comes with the risk that though there is often a time lag between the time the policy is made and the time it is implemented across the economy, so up-to-the-minute analysis of the policy is impossible. The central bank must know when to stop the supply of money in the economy and apply a Contractionary Policy.
• A Neutral Policy : If a central bank says that it has no particular stance, but will observe the situation as it develops, and act accordingly, then we have a Neutral Stance.

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