Money Supply Expansion: Central Bank's Open Market Operations - Essay Sample

Introduction

The control and regulation of the money market are conducted by the Central bank through its open market operations tools. Therefore, any approach taken by the country's Central bank to increasing or decreasing the supply of money in the economy is called the expansionary monetary policy (Hubbard & Garnett, 2012). The policy can be attained in the open market by buying government bonds. In most economies that are growing, there is a regular expansion of money supply to ensure it keeps up with the expanding GDP. To cut interest rates will result in a rise in the entire demand in the economy. Thus, low rates of interest offer a cheaper way to borrow, which encourages firms to invest and ensure more consumer spending. Also, it is going to lower the rates on the cost of mortgage interest repayments.

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The Federal Reserve is mandated to replace the bank's treasury notes using credit, through which it offers more money to lend. Lending out the extra cash will result in the banks to lower the lending rates. Subsequently, it reduces the interest rates charged on credit cards, which boosts consumer spending. The financial market has a wide range of interest rates that represent borrowers that have varying risk premium and loans that required to be paid within a given time (Free, 2010). Therefore, it will result in federal funds rate dropping substantially, which will result in a decline in other interest rates. Subsequently, monetary policy can result in the entire spectrum of interest to be high or low, but the specific interest rates are set by forces of supply and demand in the markets for lending or borrowing.

The central bank causes the supply of money and loanable funds to rise in an expansionary monetary policy that results in the lowered interest rate. This will have the ability to stimulate more borrowing for investing and consuming leading to a shift of aggregate demand to the right. Therefore, the economy will experience a high price level in the short run that is going to raise the GDP. Also, by reducing the interest rates, the Central bank can decide to follow a quantitative easing policy to increase the money supply and decrease the long-term interest rates (Free, 2010). Under the policy, money is created by the Central bank, which is used to purchasing from commercial banks the government bonds. Thus, this will raise the monetary base and bank's cash reserves that will allow for higher lending. Subsequently, it reduces the bonds interest rates that are crucial in making investments.

Expansionary monetary policy has an ability to causing significant economic growth and reducing the rates of unemployment, but it can result in a high rate of inflation (Hubbard & Garnett, 2012). For instance, to a given extent, the expansionary monetary policy that was adopted during the 2008 financial crisis assisted in economic recovery. However, the expansionary monetary policy can fail to work due to varying factors such as low confidence by people that are not will to invest or raise their spending despite the availability of lower interest rates. Depending on the components of aggregate demand, the adopted expansionary monetary policy will be able to raise consumer spending. However, in the event of a global recession, it can result in a significant fall in exports that will outweigh enhancing consumer spending.

References

Free, R. C. (2010). 21st century economics: A reference handbook. Thousand Oaks, Calif: SAGE.

Hubbard, G., & Garnett, A. (2012). Essentials of Economics. Pearson Australia Pty Ltd.