Chapter 15: Problem 26

Which kind of monetary policy would you expect in response to recession: expansionary or contractionary? Why?

Short Answer

Expert verified

In response to a recession, we would expect an expansionary monetary policy. This is because the primary objective during a recession is to stimulate economic growth by increasing the money supply, lowering interest rates, and making it easier for businesses and consumers to access credit. This encourages borrowing, spending, and investment, helping the economy recover from the recession.

Step by step solution

Understanding Monetary Policy

Monetary policy is the process by which a central bank or monetary authority manages the money supply in an economy to achieve specific economic goals such as controlling inflation, maximizing employment, and promoting economic growth. There are two types of monetary policies: expansionary and contractionary.

Expansionary Monetary Policy

An expansionary monetary policy is used to stimulate economic growth during a recession or low economic activity. It involves increasing the money supply in the economy, lowering interest rates, and making it easier for businesses and consumers to access credit. This encourages more borrowing, spending, and investment, which increases demand and helps the economy to grow.

Contractionary Monetary Policy

A contractionary monetary policy is used to slow down an overheating economy or to control inflation. It involves decreasing the money supply in the economy, raising interest rates, and making it harder for businesses and consumers to access credit. This discourages borrowing, spending, and investment, which reduces demand and helps to slow down the economy.

Analyzing the Situation: Recession

In a recession, economic activity is below its potential, and the economy experiences negative growth, high unemployment, and lower incomes. The objective during a recession is to stimulate economic growth and restore it to its full potential.

Expected Monetary Policy: Expansionary

In response to a recession, we would expect an expansionary monetary policy. This is because the primary objective during a recession is to stimulate economic growth, which can be achieved by increasing the money supply, lowering interest rates, and making it easier for businesses and consumers to access credit. As a result, borrowing, spending, and investment are encouraged, helping the economy recover from the recession. So in conclusion, during a recession, an expansionary monetary policy would be expected, as it helps to promote economic growth and recovery by increasing the money supply, lowering interest rates, and encouraging borrowing, spending, and investment.