Question

Which action is an example of an expansionary monetary policy?

Answer 1

Answer:

Lowering the banks' reserve requirement (option C) is an example of the Fed's expansionary monetary policy tool.

Explanation:

General Concepts:

Monetary policy.

Expansionary monetary policy.

Contractionary monetary policy.

Open market operations.

Open market sale.

What is a Monetary Policy?

The Federal Reserve (or the Fed) implements its monetary policy by increasing or lowering the nation's money supply to achieve macroeconomic goals. The two types of monetary policies are expansionary and contractionary monetary policies.

Expansionary Monetary Policy

The Fed implements an expansionary monetary policy during periods of recession to increase the nation's money supply and stimulate aggregate demand for goods and services. The Fed has the following tools to implement its expansionary monetary policy:

• Purchasing of government securities through the Federal Open Market Committee's (FOMC) open market operations (OMO). The OMO increases the banks' reserve account, which allows the latter to loan its excess reserves.
• Lowering the reserve requirement means that the depository institutions will only have to maintain a lesser fraction of their checkable deposits. This allows banks to loan their excess reserves, thereby stimulating investment and consumer spending.  
• Lowering the discount rate below the federal funds rate enables reserve deficient depository institutions to acquire a discount loan from The Fed at a lower discount rate.

Contractionary Monetary Policy

The Fed implements a contractionary monetary policy during periods of inflation, which decreases the nation's money supply and slows down economic growth. The following are the Fed's tools for implementing its contractionary monetary policy:

• The FOMC's open market sale of U.S. Treasury securities decreases the depository institutions' reserve account, and reduces the monetary base. Consequently, the banks will have lesser reserves to loan to borrowers.
• Increasing the required reserve ratio implies that the banks must maintain a larger portion of its required reserves. This action increases the cost of loaning funds from other banks through the federal funds market, which discourages consumer and investment spending.  
• Increasing the discount rate above the federal funds rate discourages banks to acquire discount loans from the Fed. The banks' repayment of previous discount loans to the Fed also decreases the money supply.  

Final Answer:

We can infer that lowering the banks' reserve requirement (option C) is an example of the Fed's expansionary monetary policy tool.

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