Introduction

Federal Reserve is the Central bank of the United States which was created to provide the citizens with a stable monetary and financial system. The Federal Reserve may increase or decrease money supply depending on the economic condition. The primary goal for monetary policy is to ensure that the Fed has maintained steady market prices and also ensure that there are employment opportunities as well as supporting the conditions necessary for economic growth.

The policy instruments that the Fed uses for monetary policy include; discount rates, reserve equipment, interest on reserve and also open market operations.

Open Market Operations

Open is when the Fed buys or sells treasury notes or mortgage-backed security from its member’s bank. When the Fed wants interest rates to increase, it usually sells the security to the banks.  This referred to as Contractionary Monetary Policy whereas; when they want the interest rates to go down, they buy security from the banks. The buying of security referred to as Expansionary Monetary Policy.

Pros and cons of expansionary and contractionary monetary policy

Expansionary monetary can be useful in times of recession since it stimulates business investments which in turn create employment. Contractionary fiscal policy, on the other hand, accelerates recession to depression since money supply in the market is limited.

During the depression, expansionary helps to increase money supply; hence it is the most effective. However, it can be effective during the point of a liquidity trap. This is because the interest rates can’t be reduced beyond a certain point. Contractionary monetary policy would be harmful at this period.

In times of robust economic growth, contractionary monetary policy will reduce aggregate demand whereas expansionary monetary policy will encourage investments thus increasing total demand.

During inflation, Contractionary monetary policy will be most useful since it controls money supply thus reducing inflation. Expansionary fiscal policy will be harmful to the economy since it encourages increased prices thus promoting inflation.

Conclusion

In the current economy, I would encourage the expansionary monetary policy since it reduces the interest rates hence encouraging the consumers to borrow and invest. Spending is therefore encouraged since most households have higher disposable income.

References

Ashraf, Q., Gershman, B., & Howitt, P. (2016). How inflation affects macroeconomic performance: an agent-based computational investigation. Macroeconomic Dynamics, 20(2), 558-581.

Brunnermeier, M. K., & Sannikov, Y. (2016). The I theory of money (No. w22533). National Bureau of Economic Research.

McLeay, M., Radia, A., & Thomas, R. (2014). Money creation in the modern economy.

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