This lesson explains how expansionary and contractionary monetary policy influence the supply of loanable funds and interest rates. Understanding this process clarifies what people mean when they say that a central bank raises or lowers interest rates.
Expansionary monetary policy, also called loose monetary policy, increases the supply of loanable funds. It tends to lower interest rates and encourage borrowing. A central bank can support this policy by adding reserves to the banking system through open market operations.
All flashcards
What is expansionary monetary policy?
A policy that increases the supply of loanable funds, tending to lower interest rates and encourage borrowing.
What is contractionary monetary policy?
A policy that reduces the supply of loanable funds, tending to raise interest rates and discourage borrowing.
Why may interest rates other than the federal funds rate change by a different amount?
They also depend on borrower risk, loan term, and supply and demand in their specific markets.
How can higher interest rates affect business investment?
They raise borrowing costs and can make financial investments more attractive than physical capital, tending to reduce business investment.
What is potential GDP?
The output an economy can sustain when resources are used at normal, sustainable rates.
Quiz questions
How does expansionary monetary policy typically affect the supply of loanable funds?Answer: It shifts the supply curve to the right.
What do central banks change directly through open market operations, as described in monetary policy?Answer: Bank reserves
What is the federal funds rate?Answer: The overnight interest rate on reserve-balance loans between banks.
What makes a monetary policy countercyclical?Answer: It acts against the direction of the business cycle.
What does the zero lower bound limit?Answer: Conventional interest-rate cuts when the target rate approaches zero.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.