6. Contractionary and Expansionary Monetary Policies and the Neutral Rate
m. determine whether a monetary policy is expansionary or contractionary;
n. describe limitations of monetary policy;
What is an expansionary vs contractionary monetary policy?
- An expansionary monetary policy decreases the interest rate in order to increase the size of the money supply
- A contractionary monetary policy increases the interest rate in order to decrease the size of the money supply
What is a "neutral rate of interest"? What is the math formula?
- A neutral rate of interest is a rate of interest that neither deliberately seeks to stimulate aggregate demand and growth nor deliberately seeks to weaken growth from its current level. In other words, a neutral rate of interest would be one that encourages a rate of growth of demand close to the estimated trend rate of growth of real GDP.
Neutral rate = Trend growth + Inflation target
What is a demand shock?
A demand shock is a sudden surprise event that increases or decreases demand.
What is quantitative easing (QE)?
In quantitative easing (QE), a central bank buys any financial assets to inject money into the economy. It is different from the traditional policy of buying or selling government bonds to keep market interest rates at a specified target value.