Expansionary vs Contractionary Monetary
Policy
Understand the difference between Expansionary and Contractionary
Monetary Policy.
Monetary policy refers to the actions undertaken by a nation’s central bank to
control the money supply. Control of money supply helps to manage inflation
or deflation.
In India, the Reserve Bank of India (RBI) is in charge of the Monetary Policy.
The monetary policy can be expansionary or contractionary.
What is an Expansionary Monetary Policy?
An expansionary monetary policy is focused on expanding (increasing) the
money supply in an economy.
This is also known as Easy Monetary Policy.
, An expansionary monetary policy is implemented by lowering key interest
rates thus increasing market liquidity (money supply). High market liquidity
usually encourages more economic activity.
When RBI adopt Expansionary Monetary Policy, the central bank
● decrease Policy Rates (Interest Rates) like Repo, Reverse Repo,
MSF, Bank Rate etc.
● decrease Reserve Ratios like Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio (SLR)
● buys government securities from the market as part of Open
Market Operations (OMO) – providing liquidity in the market
Now, let’s also try to understand some advanced concepts associated with an
expansionary monetary policy.
● Increase in Bond prices: Expansionary monetary policy results in a
reduction in the bank interest rates. When the rate of interest
provided by banks keeps falling, bonds which provide a fixed
interest rate for a longer duration will become more attractive. This
may drive up the demand for bonds and thus may result in an
increase in bond prices.
● Increase in Foreign bond prices: Even though the demands for
bonds as such may increase, the lower interest rates may make
domestic bonds less attractive. So the demand for domestic bonds
may fall and the demand for foreign bonds may rise.
● A decrease in the exchange rate: Lower interest rates tend to be
unattractive for foreign investment. This may decrease the
currency’s relative value. Reduction in interest rate may result in
less foreign investment and thus less foreign currency. As the
demand for domestic currency falls and the demand for the foreign
currency rises, a decrease in the exchange rate may happen.
Policy
Understand the difference between Expansionary and Contractionary
Monetary Policy.
Monetary policy refers to the actions undertaken by a nation’s central bank to
control the money supply. Control of money supply helps to manage inflation
or deflation.
In India, the Reserve Bank of India (RBI) is in charge of the Monetary Policy.
The monetary policy can be expansionary or contractionary.
What is an Expansionary Monetary Policy?
An expansionary monetary policy is focused on expanding (increasing) the
money supply in an economy.
This is also known as Easy Monetary Policy.
, An expansionary monetary policy is implemented by lowering key interest
rates thus increasing market liquidity (money supply). High market liquidity
usually encourages more economic activity.
When RBI adopt Expansionary Monetary Policy, the central bank
● decrease Policy Rates (Interest Rates) like Repo, Reverse Repo,
MSF, Bank Rate etc.
● decrease Reserve Ratios like Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio (SLR)
● buys government securities from the market as part of Open
Market Operations (OMO) – providing liquidity in the market
Now, let’s also try to understand some advanced concepts associated with an
expansionary monetary policy.
● Increase in Bond prices: Expansionary monetary policy results in a
reduction in the bank interest rates. When the rate of interest
provided by banks keeps falling, bonds which provide a fixed
interest rate for a longer duration will become more attractive. This
may drive up the demand for bonds and thus may result in an
increase in bond prices.
● Increase in Foreign bond prices: Even though the demands for
bonds as such may increase, the lower interest rates may make
domestic bonds less attractive. So the demand for domestic bonds
may fall and the demand for foreign bonds may rise.
● A decrease in the exchange rate: Lower interest rates tend to be
unattractive for foreign investment. This may decrease the
currency’s relative value. Reduction in interest rate may result in
less foreign investment and thus less foreign currency. As the
demand for domestic currency falls and the demand for the foreign
currency rises, a decrease in the exchange rate may happen.
