Definition of expansive monetary policy
What is an expansive monetary policy?
An expansive monetary policy is activity by the central bank to stimulate economic activity in a country or geographical area. This type of policy is adopted in times of economic recession or early recovery. The effect of expansive monetary policy is to increase the money supply.
Expansive monetary policy instruments
The main instrument of an expansive monetary policy is reduction of policy rates by the central bank. This reduction in rates makes it possible to foster the right conditions for obtaining credit for economic agents (households and businesses) and so increase investment and consumption. In the long term, it therefore supports economic growth. It is a conventional monetary policy measure.
To boost growth, there are also non-conventional monetary policy measures. These are the open market operations which are part of quantitative easing. This expansive monetary policy consists of massive purchases of securities on the interbank market (treasury bills, assets backed by doubtful loans, etc.) to indirectly inject liquidity into the economy. By doing so, the central bank enables commercial banks to get rid of the securities they no longer want and thus clean up their balance sheets. In this way, commercial banks can provide more credit to economic agents. The ultimate objective of this expansive policy is to boost economic growth by increasing the money supply.
Risks of an expansive monetary policy
An expansive monetary policy can fail. Despite the stimulus measures, economic activity may remain weak. This is the case if commercial banks are reluctant to grant more credit despite the increase in the money supply (with quantitative easing and lower key rates). The country may then find itself on a drip, and unable to do without expansive measures. It is then very difficult for the central bank to stop its expansive monetary policy or risk plunging the country into a severe economic recession. This is what Japan has been going through for several decades. The central bank has no choice but to pursue its expansive monetary policy.
The other risk of an expansive monetary policy is that it generates too much inflation. If inflation is too high, it eventually hinders economic growth and prevents a recovery in activity.