Loading the player...

What is an 'Expansionary Policy'

An expansionary is a macroeconomic policy that seeks to encourage economic growth or combat inflationary price increases by expanding the money supply, lowering interest rates, increasing government spending or cutting taxes. One form of expansionary policy is fiscal policy, which comes in the form of tax cuts, transfer payments, rebates and increased government spending on projects such as infrastructure improvements. Another form is monetary policy, which is enacted by central banks and comes about through open market operations, reserve requirements and setting interest rates.

The most common form of expansionary policy is through the implementation of monetary policy. The U.S. Federal Reserve employs expansionary policies whenever it lowers the benchmark federal funds rate or discount rate, decreases required reserves for banks or buys Treasury bonds on the open market. Quantitative easing, or QE, is another form of expansionary monetary policy.
 

BREAKING DOWN 'Expansionary Policy'

For example, when the benchmark federal funds rate is lowered, the cost of borrowing from the central bank decreases, giving banks greater access to cash that can be lent in the market. When reserve requirements decline, it allows banks to lend a higher proportion of their capital to consumers and businesses. When the government purchases debt instruments, it injects capital directly into the economy.

From a fiscal perspective, the government enacts expansionary policies through budgeting tools that provide people with more money. For example, it can increase discretionary government spending, infusing the economy with more money through government contracts. Additionally, it can cut taxes and leave a greater amount of money in the hands of the people who then go on to spend and invest.

The Risks of Expansionary Monetary Policy

Expansionary policy is a useful tool for managing low-growth periods in the business cycle, but it also comes with risks. Economists must know when to expand the money supply to avoid causing side effects, such as high inflation. There is also a time lag between when a policy move is made and when it works its way through the economy. This makes up-to-the-minute analysis nearly impossible, even for the most seasoned economists. Prudent central bankers and legislators must know when to halt money supply growth or even reverse course and switch to a contractionary policy, which would involve taking the opposite steps of expansionary policy, such as raising interest rates.

An Example of Expansionary Policy

Declining oil prices from 2014 through the second quarter of 2016 caused many economies to slow down. Canada was hit specifically hard in the first half of 2016, with almost one-third of its entire economy based in the energy sector. This has caused bank profits to decline, making Canadian banks vulnerable to a recession. To combat these low oil prices, Canada was expected to enact an expansionary monetary policy by reducing interest rates within the country. The expansionary policy was targeted to boost economic growth domestically. However, the policy could also have meant a decrease in net interest margins for Canadian banks, squeezing bank profits.

Another example is the policy following the 2008 financial crisis, where central banks around the world lowered interest rates to near zero, and performed other measures such as multiple rounds of quantitative easing. This helped keep the Great Recession from turning into a full-blown economic depression and helped along the albeit slow recovery that followed.

RELATED TERMS
  1. Tight Monetary Policy

    A tight monetary policy is a course of action undertaken by a ...
  2. Contractionary Policy

    A contractionary policy is a macroeconomic tool used by a country's ...
  3. Easy Money

    Easy money is when the Federal Reserve allows cash flow to build ...
  4. Federal Reserve Bank Of Richmond

    The Federal Reserve bank of Richmond is responsible for the fifth ...
  5. Deflationary Spiral

    A deflationary spiral is a downward price reaction to an economic ...
  6. Reserve Requirements

    Reserve requirements refer to the amount of cash that banks must ...
Related Articles
  1. Insights

    Fiscal Policy vs. Monetary Policy: Pros & Cons

    When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two courses of action: monetary policy or fiscal policy.
  2. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  3. Insights

    Open Market Operations vs. Quantitative Easing

    How does the Fed's implementation of Quantitative Easing differ from its more conventional open market operations?
  4. Insights

    Central Banks Not Equipped for Recession: Bank of America

    As inflation rates remain benign central banks are in no position to handle another recession.
  5. Insights

    Chicago PMI Misses, Falls Back Into Contraction

    ISM's Chicago PMI disappointed analysts, who expected it to remain in expansionary territory. The index has been see-sawing all year, and investors are looking
  6. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  7. Insights

    Central Bank

    They print money, they control inflation, they are known as the "lender of last resort". Check out the role of Central Bank nd how its role evolved overtime.
  8. Investing

    Quantitative Easing vs. Currency Manipulation

    Is QE a form of currency manipulation or an unintentional consequence?
RELATED FAQS
  1. How does fiscal policy impact the budget deficit?

    Find out how the different uses of fiscal policy impact a government's budget deficit, and the difference between contractionary ... Read Answer >>
  2. 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 >>
  3. How Do Fiscal and Monetary Policies Affect Aggregate Demand?

    Learn about the impact fiscal and monetary policy have on aggregate demand, and discover how the government influences economic ... Read Answer >>
  4. 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 >>
  5. 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 >>
  6. What can policymakers do to decrease cyclical unemployment?

    Learn about the tools available to policymakers to reduce cyclical unemployment, and find out more about the role of expansionary ... Read Answer >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center