What is an Accommodative Monetary Policy
Accommodative monetary policy occurs when a central bank (such as the Federal Reserve) attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP). The policy is implemented to allow the money supply to rise in line with national income and the demand for money.
Accommodative monetary policy is also known as "easy monetary policy" or "loose credit policy."
BREAKING DOWN Accommodative Monetary Policy
When the economy slows down, the Federal Reserve can implement an accommodative monetary policy to stimulate the economy. It does this by running a succession of decreases in the Federal funds rate, making the cost of borrowing cheaper. Accommodative money policy is triggered to encourage more spending from consumers and businesses by making money less expensive to borrow through the lowering of short-term interest rates.
When money is easily accessible through banks, the money supply in the economy increases. This leads to increased spending. When businesses can easily borrow money, they have more funds to expand operations and hire more workers, which means that the unemployment rate will decrease. On the other hand, people and businesses tend to save less when the economy is stimulated due to the low savings interest rates offered by banks. Instead, any additional funds are invested in the stock market, pushing up stock prices.
While accommodative monetary policy expands economic growth mid-term, there may be negative repercussions in the long-term. If money supply is loosened for too long, there will be too much money chasing too few goods and services, leading to inflation. To avoid inflation, most central banks alternate between the accommodative monetary policy and the tight monetary policy in varying degrees to encourage growth while keeping inflation under control. A tight monetary policy is implemented to contract economic growth. Converse to an accommodative monetary policy, a tight monetary policy involves increasing interest rates to constrain borrowing and to stimulate savings.
The Federal Reserve adopted an accommodative monetary policy during the late stages of the bear market that began in late 2000. When the economy finally showed signs of a rebound, the Fed eased up on the accommodative measures, eventually moving to a tight monetary policy in 2003. Also, to overcome the recession following the 2008 credit crisis, an accommodative monetary policy was implemented and interest rates were cut to 0.5%.
To increase the supply of money in the economy, the Federal Reserve can also purchase Treasuries on the open market to infuse capital into a weakening economy.