Describe a situation where a central bank would want to implement expansionary monetary policy.
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A central bank may want to implement expansionary monetary policy to stimulate economic growth and increase inflation. This policy is usually employed during times of economic downturn or recession when there is a decline in overall economic activity, high unemployment rates, and weak consumer and business spending.
One situation where a central bank may implement expansionary monetary policy is during a severe recession or economic crisis. For instance, during the global financial crisis of 2008, many central banks around the world, including the Federal Reserve in the United States, adopted expansionary monetary policy to counteract the sharp contraction in economic activity.
In such a situation, the central bank would typically engage in open market operations, where it buys government securities, such as bonds, from financial institutions. This injects money into the economy, increasing liquidity and encouraging banks to lend more to businesses and consumers. By lowering interest rates, the central bank makes it cheaper for households and firms to borrow money, thereby stimulating consumption and investment spending.
Additionally, the central bank may lower the reserve requirement for banks, which means that banks need to keep less money in reserve and can lend more to businesses and individuals. This further boosts economic activity and encourages banks to extend credit to borrowers.
The central bank may also use forward guidance, where it communicates its intentions to keep interest rates low for an extended period. This helps manage expectations and encourages businesses and consumers to make investments or purchase goods and services, fostering economic growth.
Expansionary monetary policy can also be used to combat deflationary pressures. During periods of falling prices, consumers and businesses postpone purchases, expecting prices to decrease further. This leads to a decrease in demand and economic activity. By implementing expansionary monetary policy, the central bank aims to increase inflation expectations, encouraging spending and investment by making it less attractive to hoard money.
Overall, a central bank would want to implement expansionary monetary policy in situations where there is a need to revive economic activity, boost employment, increase inflation, and prevent deflationary pressures.
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