Expansionary policy is a macroeconomics strategy that seeks to stimulate the economy by expanding the money supply. When more capital is injected into the economy, banks have more money to lend, businesses have more money to expand and hire, and consumers have more money to spend. Expansionary policy may be set by the government in the form of tax cuts or government spending, or it may be set by the Federal Reserve as interest rate cuts or Treasury bond purchases.

Tax cuts expand the money supply by keeping more money in the pockets of individuals and businesses. When individuals have more discretionary income because they do not have to give as much of it to the government, they can spend more and save more, and both actions have beneficial effects on the economy. When taxes are lowered on businesses, those companies retain more capital that they can put into research and development, acquisitions and hiring.

The government can also increase the money supply by spending. As opposed to cutting taxes, the government injects a portion of the money it receives in tax receipts back into the economy by spending it in certain areas. Common spending projects undertaken by the government to stimulate the economy include infrastructure spending, education spending and expanding the social safety net through food stamps and unemployment benefits. According to the multiplier effect, government spending has the ability to grow the economy by an amount greater than the money spent to do so.

Apart from the federal government, the Federal Reserve has the largest influence on economics in the United States as it exercises control over interest rates. The Federal Reserve controls the federal funds rate, the interest rate at which private banks borrow money from the federal government. A low federal funds rate encourages banks to borrow more, which increases the money supply as banks have more capital to lend to businesses and individuals. Conversely, a high federal funds rate constricts the money supply – banks refrain from borrowing because they do not want to be saddled with high interest payments. One of the most popular types of expansionary policy is an interest rate reduction by the Federal Reserve; this tactic has been employed during nearly every U.S. recession since the Great Depression.

Another tactic at the Federal Reserve's disposal to expand the money supply is purchasing U.S. Treasury bonds from the open market. A Treasury bond is a government debt security that pays interest over a fixed number of years on the bond's face value. A bond purchase by the Federal Reserve is expansionary because it injects money into the economy. When the Federal Reserve wants to tighten the money supply, perhaps to reign in inflation, it removes money from circulation by selling Treasury bonds.

  1. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
  2. How is money supply used in monetary policy?

    Learn about the three components of the Federal Reserve's monetary policy. Understand how these three components use the ... Read Answer >>
  3. What are some examples of expansionary fiscal policy?

    Learn about expansionary fiscal policy – tax cuts and government spending – that are used by governments to boost spending ... Read Answer >>
  4. What happens if the Federal Reserve lowers the reserve ratio?

    Learn about the Federal Reserve's monetary policy and the tools it uses to control it. Understand what happens if the Federal ... Read Answer >>
  5. Why would the Federal Reserve change the reserve ratio?

    Understand the Federal Reserve's monetary policy and the tools it uses to change that monetary policy. Learn about the reserve ... Read Answer >>
  6. What are the implications of a high Federal Funds Rate?

    Learn the implications of a high federal funds rate, which include constriction of the money supply, a stronger dollar and ... Read Answer >>
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