Expansionary monetary policy is implemented when it is required to increase economic activities and consequently the GDP. An example of the monetary policy includes the “Great Recession of 2007-2009” when the Federal Reserve reduced the interest rate from 5.25% to 0% in 2008 to increase the money supply in the market (Hussain, 2020). Although the Federal Reserve utilized all the tools of expansionary policy to combat the recession, the economy was not fully recovered which consequently led the bank to use quantitative easing for open market operations.
As opposite to expansionary monetary policy, “Contractionary Monetary Policy” is implemented when the central bank wants to reduce the money supply in the market to prevent the excessive growth of the economy that can lead to unwanted inflation. The period of the late 1970s is a good example of contractionary monetary policy when the federal reserves increased the interest rate to combat the increasing inflation rate which was already reached 8.7% in 1973 (Hussain, 2020b). Consequently, the inflation rate decreased to 6% at the end of the decade.
Monetary Policy of Federal Reserve
As shown earlier, during the time of the recession, the Fed implemented the expansionary monetary policy to combat the rapid decline in the economy which led to the negligible interest rate and the quantitate easing. Since improving economic growth is the main objective of the expansionary policy, the Fed is currently implementing an expansionary monetary policy to cope with the unemployment caused due to business shutdown during the pandemic. Moreover, as noted by Associated Press (2021), the Fed is intended to keep the interest rates low till 2023 along with buying government bonds to continuously supply money in the market and promote economic activities. As discussed above, these are the prominent tools of contractionary monetary policy.
Associated Press. (2021). Fed Stresses Its Commitment to Low Rates as Economy Stumbles. US News & World Report; U.S. News & World Report. https://www.usnews.com/news/business/articles/2021-01-27/fed-stresses-its-commitment-to-low-rates-for-the-long-run
Hussain, A. (2020a). How the Federal Reserve uses expansionary monetary policy to stimulate growth during an economic downturn. Business Insider. https://www.businessinsider.com/what-is-expansionary-monetary-policy
Hussain, A. (2020b). Why the Federal Reserve uses contractionary monetary policy to curb the inflation that accompanies an overheating economy. Business Insider. https://www.businessinsider.com/what-is-contractionary-monetary-policy