Generally, expansionary and contractionary monetary policies entail altering money supply levels in an economy. The monetary policy of expansionary basically means expanding or increasing money supply in an economy while on the other hand contractionary monetary policy simply contracts or reduces the supply of money in the economy. Expansionary and contractionary monetary policies are thus used for regulating the amount of money in a given economy. The monetary authorities of various nations are the ones that are mainly mandated to implement these monetary policies. During the periods of high inflation when the prices of goods and services are increasing without a corresponding increase in value of such goods and services the contractionary monetary policy is applied in order to reduce the amount of money in circulation. On the other hand, expansionary monetary policies are used during periods of deflation in order to increase the amount of money in circulation and thus stimulate the economy (Moffatt, 2009).
Differences between expansionary and contractionary monetary policy
The main difference between the expansionary and the contractionary monetary policies is that while the contractionary monetary policy reduces the amount of money in the economy, the expansionary monetary policy on the other hand increases the amount of money in the economy. They are thus used at different times when each is appropriate. For the expansionary monetary policy to be used, the economy must be in need of more money. In order to increase money supply in the economy, the monetary authorities responsible for regulating the amount of money in the economy can do so by buying securities in the open market, that is open market operations. Money supply can also be increased by decreasing federal discount rate and finally money supply can be increased by reducing the reserve requirements. When the above three moves are made, money supply in the economy is increased and hence the economy is stimulated (Arnold, 2008).
When there is excess of money in circulation, which is having a negative impact on the economy, the monetary authorities with the responsibility of regulating the amount of money in the economy basically make use of the contractionary monetary policy. In order to reduce the excess money in circulation, the monetary authorities can sell government securities in the open market that is through the open market operations. They can also increase the discount rate or they can increase the reserve requirements of the commercial banks.
When the above steps are taken in order to regulate the amount of money in circulation, they impact directly on the rate of interest. When they are taken in order to increase the amount of money in circulation, they have the effect of lowering the rate of interests. As a result, the cost of borrowing decreases and thus borrowing money becomes more affordable making more people to borrow more money from the commercial banks and other financial institutions. The opposite takes place during periods of excess of cash in the economy the interest rates are considerably increasing. Unlike in the case of expansionary monetary policy, in the case of contractionary monetary policies, the increased interest rates increase the cost of borrowing making many people to shy away from borrowing a lot of money from the commercial banks and other financial institutions. The implication of this is decreased money supply in the economy (Gupta, 2004).
The contractionary monetary policies that are used in various nations have the effect of increasing the cost of borrowing money in the economy. This is due to the fact that the cost of borrowing money just like any other commodity in the market is affected by its demand and supply. Since contractionary monetary policies usually have the effects of reducing the supply of money in the market, demand for money thus increases and in the end, the cost of borrowing money is on the rise. However, unlike in the case of other commodities whose supply can be increased as a result of an increase in their price, the same is not applicable with money since it is usually regulated by a central body (Moffatt, 2009).
While the contractionary monetary policies increase the cost of borrowing money in an economy, the expansionary monetary policies have a direct opposite effect. They reduce the cost of borrowing money through reduced interest rates. The monetary authorities ease various terms they usually impose on the commercial banks and other financial institutions. This enables these financial institutions to lower their rates of interest and thus make the cost of borrowing money in the economy lower than in case of a contractionary monetary policy (Arnold, 2008).
Despite the fact that both expansionary and contractionary monetary policies use the same tools, they use them differently. The policy tools that are used by these monetary policies include monetary base, reserve requirements, discount window lending and interest rates. In the case of the monetary base, the contractionary policies are basically implemented through reducing the monetary base size. As a result, the money that is available in circulation is directly reduced. The central bank of a country can make use of open market operations in order to effect a reduction in the monetary base. In this case, the central bank basically sells bonds so as to exchange them with the hard currency. After the central bank or any other authority responsible for regulating the amount of money in the economy collects the payment of hard currency, it withdraws such amount of hard currency and it therefore cannot circulate in the economy, thereby making the monetary base to contract (Moffatt, 2009).
On the other hand, in the case of expansionary monetary policies, it is usually implemented by increasing the monetary base size. The increased monetary magnitude directly increases the amount of cash that is circulating in a given economy. The central bank or the monetary authority with the mandate of regulating the amount of money in circulation utilizes the operations of the open market just like in the case of contractionary monetary policies, but in this case it uses these open market operations in order to increase the base of the monetary. The central bank in this case buys the bonds in order to get rid of the hard currency. The central bank thus injects the hard currency into the economy thus expanding the base of the monetary (Gupta, 2004).
In the case of reserve requirements, the monetary authorities exercise regulatory control on the commercial banks. The contractionary policies in this case are implemented by making these banks retain a bigger proportion of all their assets as reserve. Therefore, the banks just retain a small fraction of all their assets in form of cash that is available for instant withdrawal. All the other money is invested in solid assets such as loans and mortgages. When the reserves are increased, the ministry of finance or the central bank of a country effectively decrease the funds available for lending as a result, money supply into the economy is reduced. The opposite is true in the case of expansionary monetary policies, the reserve level is reduced and thus the banks are left with more money in liquid form to lend to their customers. The effect of this is increased money supply in the market because more money is available (Gupta, 2004).
In the discount window, lending several central banks around the world or ministries of finance usually have authority of lending funds to commercial banks and other financial institutions within their nations. By calling in the loans that already exist the central bank can thus directly decrease the magnitude of money supply in order to implement the contractionary monetary policy. However, in the case of an expansionary monetary policy, the central banks or the ministries of finance instead of calling such loans, they increase the loans thereby directly increasing the money supply size (Arnold, 2008).
Even though both expansionary and contractionary monetary policies are economic tools used for stabilizing the economy, they are used very differently and in completely different situations. Traditionally, expansionary monetary policies were used for reducing the rate of unemployment, especially during the period of recession. It manages to do this by reducing the rates of interest thus making the employers to have more money and thus be in a position of employing more people. On the other hand, the contractionary monetary policies were used for curbing inflation by increasing the rates of interest and thus reducing the amount of money in circulation (Gupta, 2004).
Expansionary and contractionary monetary polices have different effects on the level of activities in an economy. Expansionary policies ensure that there is more money in circulating in the economy. This money increases the level of activity in the economy since money changes hands faster and thus more commerce is realized in the economy. It can be appropriately used when the level of activities in the economy are low and thus stimulate the economic growth in a country. Contractionary monetary policies on their part usually have the effect of reducing the level of activities within the economy. When there is less money circulating in a given economy, the level of activities also decreases accordingly. Unlike in the case of expansionary monetary policy whereby the economy is stimulated, the decreased level of activities as a result of contractionary policies can harm the economy. They should both be used in such a manner that at the end of the day, they impact positively to the economy (Moffatt, 2009).
The main difference between a contractionary policy and an expansionary policy is that whereas the contractionary policy is aimed at decreasing the amount of money supplying in an economy, the expansionary policy aims at increasing the money circulating in an economy. Contractionary policies thus make money less available in an economy while the expansionary policies increase money availability in an economy. The cost of borrowing money or the interest rate is increased under contractionary policy whereas the same is reduced under the expansionary policy. Furthermore, whereas the expansionary policies can be used for reducing the rate of unemployment in a country, the contractionary policies are used for curbing inflation in an economy.
Differences between expansionary and contractionary monetary policy
The main difference between the expansionary and the contractionary monetary policies is that while the contractionary monetary policy reduces the amount of money in the economy, the expansionary monetary policy on the other hand increases the amount of money in the economy. They are thus used at different times when each is appropriate. For the expansionary monetary policy to be used, the economy must be in need of more money. In order to increase money supply in the economy, the monetary authorities responsible for regulating the amount of money in the economy can do so by buying securities in the open market, that is open market operations. Money supply can also be increased by decreasing federal discount rate and finally money supply can be increased by reducing the reserve requirements. When the above three moves are made, money supply in the economy is increased and hence the economy is stimulated (Arnold, 2008).
When there is excess of money in circulation, which is having a negative impact on the economy, the monetary authorities with the responsibility of regulating the amount of money in the economy basically make use of the contractionary monetary policy. In order to reduce the excess money in circulation, the monetary authorities can sell government securities in the open market that is through the open market operations. They can also increase the discount rate or they can increase the reserve requirements of the commercial banks.
When the above steps are taken in order to regulate the amount of money in circulation, they impact directly on the rate of interest. When they are taken in order to increase the amount of money in circulation, they have the effect of lowering the rate of interests. As a result, the cost of borrowing decreases and thus borrowing money becomes more affordable making more people to borrow more money from the commercial banks and other financial institutions. The opposite takes place during periods of excess of cash in the economy the interest rates are considerably increasing. Unlike in the case of expansionary monetary policy, in the case of contractionary monetary policies, the increased interest rates increase the cost of borrowing making many people to shy away from borrowing a lot of money from the commercial banks and other financial institutions. The implication of this is decreased money supply in the economy (Gupta, 2004).
The contractionary monetary policies that are used in various nations have the effect of increasing the cost of borrowing money in the economy. This is due to the fact that the cost of borrowing money just like any other commodity in the market is affected by its demand and supply. Since contractionary monetary policies usually have the effects of reducing the supply of money in the market, demand for money thus increases and in the end, the cost of borrowing money is on the rise. However, unlike in the case of other commodities whose supply can be increased as a result of an increase in their price, the same is not applicable with money since it is usually regulated by a central body (Moffatt, 2009).
While the contractionary monetary policies increase the cost of borrowing money in an economy, the expansionary monetary policies have a direct opposite effect. They reduce the cost of borrowing money through reduced interest rates. The monetary authorities ease various terms they usually impose on the commercial banks and other financial institutions. This enables these financial institutions to lower their rates of interest and thus make the cost of borrowing money in the economy lower than in case of a contractionary monetary policy (Arnold, 2008).
Despite the fact that both expansionary and contractionary monetary policies use the same tools, they use them differently. The policy tools that are used by these monetary policies include monetary base, reserve requirements, discount window lending and interest rates. In the case of the monetary base, the contractionary policies are basically implemented through reducing the monetary base size. As a result, the money that is available in circulation is directly reduced. The central bank of a country can make use of open market operations in order to effect a reduction in the monetary base. In this case, the central bank basically sells bonds so as to exchange them with the hard currency. After the central bank or any other authority responsible for regulating the amount of money in the economy collects the payment of hard currency, it withdraws such amount of hard currency and it therefore cannot circulate in the economy, thereby making the monetary base to contract (Moffatt, 2009).
On the other hand, in the case of expansionary monetary policies, it is usually implemented by increasing the monetary base size. The increased monetary magnitude directly increases the amount of cash that is circulating in a given economy. The central bank or the monetary authority with the mandate of regulating the amount of money in circulation utilizes the operations of the open market just like in the case of contractionary monetary policies, but in this case it uses these open market operations in order to increase the base of the monetary. The central bank in this case buys the bonds in order to get rid of the hard currency. The central bank thus injects the hard currency into the economy thus expanding the base of the monetary (Gupta, 2004).
In the case of reserve requirements, the monetary authorities exercise regulatory control on the commercial banks. The contractionary policies in this case are implemented by making these banks retain a bigger proportion of all their assets as reserve. Therefore, the banks just retain a small fraction of all their assets in form of cash that is available for instant withdrawal. All the other money is invested in solid assets such as loans and mortgages. When the reserves are increased, the ministry of finance or the central bank of a country effectively decrease the funds available for lending as a result, money supply into the economy is reduced. The opposite is true in the case of expansionary monetary policies, the reserve level is reduced and thus the banks are left with more money in liquid form to lend to their customers. The effect of this is increased money supply in the market because more money is available (Gupta, 2004).
In the discount window, lending several central banks around the world or ministries of finance usually have authority of lending funds to commercial banks and other financial institutions within their nations. By calling in the loans that already exist the central bank can thus directly decrease the magnitude of money supply in order to implement the contractionary monetary policy. However, in the case of an expansionary monetary policy, the central banks or the ministries of finance instead of calling such loans, they increase the loans thereby directly increasing the money supply size (Arnold, 2008).
Even though both expansionary and contractionary monetary policies are economic tools used for stabilizing the economy, they are used very differently and in completely different situations. Traditionally, expansionary monetary policies were used for reducing the rate of unemployment, especially during the period of recession. It manages to do this by reducing the rates of interest thus making the employers to have more money and thus be in a position of employing more people. On the other hand, the contractionary monetary policies were used for curbing inflation by increasing the rates of interest and thus reducing the amount of money in circulation (Gupta, 2004).
Expansionary and contractionary monetary polices have different effects on the level of activities in an economy. Expansionary policies ensure that there is more money in circulating in the economy. This money increases the level of activity in the economy since money changes hands faster and thus more commerce is realized in the economy. It can be appropriately used when the level of activities in the economy are low and thus stimulate the economic growth in a country. Contractionary monetary policies on their part usually have the effect of reducing the level of activities within the economy. When there is less money circulating in a given economy, the level of activities also decreases accordingly. Unlike in the case of expansionary monetary policy whereby the economy is stimulated, the decreased level of activities as a result of contractionary policies can harm the economy. They should both be used in such a manner that at the end of the day, they impact positively to the economy (Moffatt, 2009).
The main difference between a contractionary policy and an expansionary policy is that whereas the contractionary policy is aimed at decreasing the amount of money supplying in an economy, the expansionary policy aims at increasing the money circulating in an economy. Contractionary policies thus make money less available in an economy while the expansionary policies increase money availability in an economy. The cost of borrowing money or the interest rate is increased under contractionary policy whereas the same is reduced under the expansionary policy. Furthermore, whereas the expansionary policies can be used for reducing the rate of unemployment in a country, the contractionary policies are used for curbing inflation in an economy.
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