Examples of Expansionary Monetary Policies

There are several actions that a central bank can take that are expansionary monetary policies. Monetary policies are actions taken to affect the economy of a country. The key steps used by a central bank to expand the economy include:

• Decreasing the discount rate.
• Purchasing government securities.
• Reducing the reserve requirement.

All of these options have the same purpose; to expand the money supply for the country.

Stimulating Expansionary Monetary Policies

The central bank will often use policy to stimulate the economy during a recession or in anticipation of a recession. Expanding the money supply is meant to result in lower interest rates and borrowing costs, with the goal to boost consumption and investment.

Interest Rates

When interest rates are already high, the central bank focuses on lowering the discount rate. The discount rate is the interest rate that banks can borrow money from the Federal Reserve. There is a multitude of reasons why a bank may borrow from the Fed.

These include meeting reserve requirements, cash needed for operations, or general liquidity. Banks, however, borrow from the Fed as a last resort, preferring to borrow from other banks as the rates are lower.

The lower the discount rate, the fewer financing costs for a bank, therefore, money is cheaper. When the discount rate is lowered, banks will lower the interest rate they charge customers for borrowing money as well.

As this rate falls, corporations and consumers can borrow more cheaply. The declining interest rate makes government bonds and savings accounts less attractive, encouraging investors and savers to spend their money and invest in riskier assets.

Open Market Operations

Open market operations refer to the Fed's practice of purchasing Treasuries on the open market. This increases the demand for the securities, increases their price/decreases their yield, and injects money into the economy.

Purchasing Treasuries from banks increases their reserves, which makes it easier for them to lend out money to customers, making it easier for people to buy homes, cars, etc, and businesses to start or expand.

Quantitative Easing

When interest rates are already low, there is less room for the central bank to cut discount rates. In this case, central banks purchase government securities, usually Treasuries and agency mortgage-backed securities (MBSs). This is known as quantitative easing (QE).

QE stimulates the economy by introducing capital into the economy and lowering the interest rate as there is increased demand for fixed-income securities. It provides overall liquidity to banks as the central bank purchases assets, which increases the reserve requirements of banks, which can then use that increased liquidity to make riskier investments, such as making loans to individuals and businesses, which further stimulates the economy.

The primary difference between open market operations and quantitative easing is that open market operations is a primary tool whereas quantitative easing is an alternative tool. Also, open market operations is typically a continuous process whereas QE is only used in times of economic difficulty.

Reserve Requirement

Reserve requirements are the amount of reserves that banks are required to keep on hand as stipulated by a central bank. The reserve requirement directly relates to the amount of deposits that customers have at the institution.

Banks use customer deposits to make loans to other customers. The number of loans they can make is limited by the amount of reserves they are required to keep on hand. The more reserves they are required to keep, the less money they can lend out. The fewer reserves they are required to keep, the more money they can lend out.

During recessions, banks are less likely to loan money, and consumers are less likely to pursue loans due to economic uncertainty. The central bank seeks to encourage increased lending by banks by decreasing the reserve ratio. With more reserves on hand, banks are more likely to lend out money, thereby stimulating the economy.

Real-World Examples

The Great Recession

A recent example of expansionary monetary policy was seen in the U.S. in the late 2000s during the Great Recession. As housing prices began to drop and the economy slowed, the Federal Reserve began cutting its discount rate from 5.25% in June 2007 all the way down to 0% by the end of 2008. With the economy still weak, it embarked on quantitative easing, purchasing government securities from January 2009 until August 2014, for a total of $3.7 trillion.

COVID-19 Pandemic

In 2020, when the Coronvirus swept the world and most countries went into lockdown, economies were hit hard by the lack of economic activity. To bolster the economy, the Fed implemented a quantitative easing program.

On March 15, 2020, the Fed announced that it would purchase $500 billion in Treasury securities and $200 billion in agency MBSs to stimulate the economy.

The Bottom Line

Expansionary monetary policies are enacted by a country's central bank to help spur the economy. The goal is to increase the money supply, bring stability, and increase liquidity. The primary tools that central banks use to expand monetary policy include lowering the discount rate, increasing the purchase of government securities, and reducing the reserve requirement.