The Expansionary Economic Policy Essay

            The expansionary economic policy is the effective too that the government and the Fed may use to stimulate the economic growth. In case of the economic recession, the government and the Fed can undertake measures to stimulate the economic growth. These measures comprise the core of the expansionary economic policy and include selling government securities, the decrease of the required reserve ratio, and the decrease of the discount rate.

The essence of the expansionary economy policy

            The expansionary economic policy focuses on the economic growth and uses various tools to reach this goal. The primary means a central bank uses to implement an expansionary monetary policy is through purchasing government bonds on the open market (Cuthbertson, Nitzsche, & Hyde, 2008). Another way to enact an expansionary monetary policy is to increase the amount of discount window lending (Larch & Martins, 2009). A third method of enacting the expansionary monetary policy is by decreasing the reserve requirement (Heyne, Boettke, & Prychitko, 2002).

The necessary change in taxes and government spending

            In terms of the expansionary economic policy the government cut taxes to increase the money supply to the domestic economy and, thus, to stimulate the economic growth. The reduction of taxes eases the fiscal pressure on businesses and consumers. As a result, businesses can use financial resources to invest into their further business development, while, otherwise, they would just paid taxes before the tax cut. Consumers, in their turn, can also increase their spending, if they pay fewer taxes. As consumers spend more, the money supply increases and so do business activities because businesses respond to the increased demand and increase the supply of required products and services.

            Alternatively, the government increases spending that also has a stimulant effect on the domestic economy because the increased government spending leads to the growth of business activities and the increased money supply since the government spends more. For example, the government increases spending on the development of the infrastructure and transportation system in the time of the economic recession. As a result, government contractors get new contracts, employees get jobs, and suppliers also develop their production to supply required materials to complete government projects concerning the development of the infrastructure and the transportation system.

The effect on aggregate demand, GDP, and employment

            The combination of tax cuts and increase of the government spending have the positive impact on the aggregate demand, GDP, and employment. The aggregate demand grows because the increased government spending stimulates the growth of the production of goods to fulfill government contracts and projects funded by the government. At the same time, tax cuts stimulate spending because citizens and businesses get more money due to their savings in the result of tax cuts. Hence, they may increase spending as they have got more money after tax cuts. The increase of spending implies the growth of demand and, thus, the aggregated demand grows.

            The similar trend may be traced in case of GDP as well since GDP grows due to the growth of business activities, which increase due to tax cuts. Also GDP grows due to the increased government spending because the government funds new projects, provides social aide, and so on. As a result, the money supply increases and businesses and consumers can spend more on the business development or acquisition of more goods and services respectively. However, it is important that consumers focused on the purchase of products and services supplied by domestic companies. Otherwise, the increased money supply would just flow abroad, if consumers buy imported products only.

            The employment also tends to grow in the result of tax cuts and increased government spending. As business activities grow, companies need more employees to increase the production of goods and services. Hence, companies employ more employees and reduce the unemployment. The reduction of the unemployment increases earnings of citizens and they start increasing their spending that stimulates the further economic growth, the growth of GDP, and business activities. The increased government spending also increases the employment and reduces the unemployment rate because the implementation of government projects involves not only the use of federal or state budget funds but also human resources. As a result, government agencies and government contractors hire more employees to complete government-sponsored projects and programs.

The required reserve ratio’s increase or decrease

            The fraction of deposits that a bank must hold as reserves rather than loan out is called the reserve ratio (or the reserve requirement) and is set by the Federal Reserve (Seidman, 2007). The required reserve ratio may have a considerable impact on business activities, banking system, and the domestic economy. The increase of the required reserve ration means that banks have to reserve more money and, consequently, reduce loans as more money remain in reserve. The reduction of loans increases their costs for borrowers, i.e. businesses and consumers, and decreases business activities and spending of consumers. On the contrary, the decrease of the required reserve ratio leads to the increase of the money supply since banks can use money from their reserves to offer more loans to businesses and consumers. Briefly, the increase of the required reserve ratio leads to the decrease of the money supply because banks reserve more money and have less money to offer as loans. On the contrary, the decrease of the required reserve ratio leads to the increase of the money supply because banks transfer money from reserves and use them to increase their loan offers.  

            Interest rates also change under the impact of the increase or decrease of the required reserve ratio. As banks increase their reserves in case of the increase of the required reserve ratio, they also increase their interest rate to decrease the demand on loans. More expensive loans are less available to consumers and businesses. This is why the demand on loans drops and matches the supply. On the contrary, if the required reserve rate decreases, banks decrease their interest rate because they can offer more loans to businesses and consumers. The decrease of interest rate stimulates the growth of the loans because they become more affordable for businesses and consumers.

            Similarly, the decrease of the required reserve ratio leads to the increase of spending which occurs due to the decrease of interest rates and increase of loans. The increase of the money supply naturally leads to the increase of spending because consumers grow certain in their future and spend more as well as take more loans to purchase goods, which used to be unaffordable before. The increase of the required reserve ratio leads to the contrary effect since interests rates and, therefore, loans are less affordable, and consumers cannot spend more.

            At the same time, the decrease of the required reserve ratio leads to the growth of the aggregate demand because of the increased spending and loans available to consumers. Businesses can also invest more into the development of their operations to meet the demand. In contrast, the increase of the required reserve ratio decreases the aggregated demand because of the decrease of loans and spending. Costly loans discourage consumers to spend more. As a result, their demand drops. Similar trend may be observed in regard to the GDP rate. GDP grows due to the increase of the money supply driven by availability of loans and low interest rates and increased spending. GDP declines occur because of the decline of demand and spending determined by the high interest rate and costly loans.

            As for the employment, it also changes under the impact of the increase or decrease of the required reserve ratio. As the required reserve ratio increases, business activities decline because banks cannot offer as much loans at low interest rate as they used to offer before the increase of the required reserve rate. As a result, the decline of business activities leads to the growth of the unemployment rate because companies do not need as much employees as they used to have before the increase of the required reserve ratio. If the required reserve ratio decreases, there is a different trend in the change of the unemployment rate. The unemployment rate decreases due to the growth of business activities driven by cheap loans and increased demand driven by the increased money supply.

The discount rate’s increase or decrease

            The discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve Bank’s discount window (Seidman, 2007). The change of the discount rate may have both positive and negative impact on the economic growth. The increase of the discount rate means that Fed loans become cheaper for banks. Therefore, banks can offer cheaper loans and cheaper money to their customers. As a result, the overall effect of the discount rate has a positive impact on the economic growth and leads to the increase of the money supply. The lower discount rate means cheaper money for banks, businesses and consumers. Hence, the money supply grows as banks can borrow more money from the Fed. On the contrary, the increase of the discount rate makes Fed loans more expensive for banks and, therefore, less available. Banks can borrow less money and the money supply drops. As a result, banks can offer less loans and the economic growth declines.

            At this point, interest rates also change accordingly to the change of the discount rate. The increase of the discount rate leads to the growth of interest rate because banks borrow money from the Fed at higher rate and so they offer higher interest rate for their customers too. Instead, the decrease of the interest rate leads to lower interest rate offered by banks to their customers because banks can borrow cheaper money from the Fed.

            As a result, spending increases in the result of the decrease of the discount rate because money supply increases and banks borrow cheaper money from the Fed. As the money supply and loans become more available to businesses and consumers, they increase their spending. On the contrary, the increase of the interest rate leads to the decrease of spending because of the decline of the money supply and expensive loans.

            The aggregate demand tends to increase in response to the decrease of the discount rate because the demand grows in response to the growth of spending. As consumers can spend more money borrowed from banks at lower interest rate, they naturally increase their demand that leads to the overall growth of the aggregate demand. In contrast, the increase of the discount rate discourage consumers from spending and make them rather focused on saving because interest rate are high and make loans unattractive and the decline of the money supply makes consumers less certain in their future.

            GDP manifests similar trends in response to the decrease or increase of the discount rate. GDP grows under the impact of the growth of business activities and spending driven by the decrease of the discount rate. If the discount rate increases, the GDP growth tends to slow down because business activities and spending decline too.

            As for the employment, companies tend to hire more employees, if the discount rate drops because they can take cheaper loans from banks and invest them into their business development. As their business grows, they need more employees that leads to the reduction of the unemployment rate. In contrast, the increase of the discount rate leads to the growth of the unemployment rate because companies do not have access to cheap loans anymore and they experience difficulties with the expansion of their operations. Hence, they do not need more employees and try to save costs and increase their profits by means of cutting jobs.

Buying or selling government securities when conducting expansionary monetary policy

            Buying and selling government security in the course of the expansionary monetary policy may also influence the overall economic situation and affect the money supply, interest rate, spending, aggregate demand, GDP, and unemployment rate, although buying and selling government securities may be not as influential as the change of the discount rate, for example. Nevertheless, buying government securities tend to have a positive impact on the economic development and enhance the effectiveness of the expansionary monetary policy because it leads to the increase of the price of government securities. As the demand on government securities grows under the impact of their purchase, their price grows accordingly. Hence, the government can raise more funds to increase the government spending and government-sponsored programs. Instead, if sales of government securities prevail, then their price drops and the government may experience the shortage of financial resources that will lead to the decrease of the government spending. Therefore, buying of government securities leads to the increase of the money supply due to the increased government spending, while selling government securities leads to the decrease of the government spending and, therefore, the decrease of the money supply.

            Therefore, buying and selling government securities has influence on spending mainly, while its impact on interest rates is less significant because banks do not always change their loan polices and interest rates much in case of selling or buying government securities, although they are among the most reliable securities and banks and investors prefer to keep their money invested into government securities to be certain in the security of a part of their financial resources.

            The aggregate demand and GDP are vulnerable to less significant impact of buying or selling government securities compared to the change of the discount rate or required reserve ratio because the share of the government in the domestic economy is low and the economic growth and therefore, GDP growth as well as the growth of the aggregated demand, are driven by businesses and consumer rather than by the government. In such a situation, the employment also does not change much but it may tend to grow in case of buying government securities and drop in case of selling them.

Conclusion

            Thus, the expansionary economic policy may have a stimulating impact on the economic development and lead to the economic growth due to the increase of the money supply and growth of business activities accompanied by the decrease of the unemployment rate. This is why the expansionary economic policy can contribute to the economic growth through monetary and fiscal policies conducted by the government and the Fed.

References:

Cuthbertson, K., Nitzsche, D. and Hyde, S. (2008). Monetary policy and behavioral finance. Journal of Economic Surveys, 21(5), pp. 935-969.

Heyne, P. T., Boettke, P. J., and Prychitko, D. L. (2002). The Economic Way of Thinking (10th ed). New York: Prentice Hall.

Larch, M. and Martins, J. N. (2009). Fiscal Policy Making in the European Union: An Assessment of Current Practice and Challenges. New York: Routledge.

Seidman, L. (Fall 2007). “Reply to: “The New Classical Counter-Revolution: False Path or Illuminating Complement?””. Eastern Economic Journal. 33 (4): 563–565. 

The terms offer and acceptance. (2016, May 17). Retrieved from

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[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

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"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

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