An easy money policy is one in which a government or central bank ensures that consumer and business borrowers can readily access money. A central bank can take a variety of steps to increase the money supply, and this makes loans easier to obtain. During a recession, governments often adopt an easy money policy as a means to stimulate economic growth.
In many countries, major banks borrow money from the central bank, and in other countries, the central bank not only lends to banks but also sets the interest rates for interbank lending. Banks generate profits by borrowing money at a low interest rate and lending out the same money at a much higher interest rate. The less it costs a bank to borrow money, the less a bank charges to lend that money to consumers and businesses. Consequently, the lowering of interest rates is usually a key component of an easy money policy.
Governments can also increase the money supply by literally printing new money and using that money to buy back government bonds from banks and lenders. Banks can use this extra cash to create new loans, because consumer and business loans pay much higher yields than government bonds. A government can also relax rules related to the underwriting of loans to make it easier for people and entities with limited means or poor credit to obtain financing.
Businesses that have access to inexpensive loans can more easily afford to hire new employees, expand operations and develop new products. As businesses expand, unemployment drops and increased numbers of people have disposable income to spend at other businesses. When consumer spending increases, business profits increase and more businesses are able to expand. Aside from increased earning opportunities, consumers are more able to borrow inexpensive loans themselves and can more easily afford to buy luxury and expensive items such as cars and houses.
In the short term, an easy money policy helps prevent a country from becoming embroiled in a severe recession. Over the long term, an easy money policy causes inflation because the prices of commodities ranging from houses to gold are driven by supply and demand, and more cash means higher prices. Consequently, when an economy begins to recover from a recession, government policymakers have to carefully time the moment to change their fiscal policy. If cheap money is readily accessible for too long, inflation could become a major problem, but if the government raises interest rates to soon, it could derail the economic recovery.