What is an Expansionary Policy?

Malcolm Tatum

An expansionary policy is a strategy that is formulated to expand the money supply in a particular economy, such as a national economy. The idea behind this type of policy is to ease the effects of inflation while also promoting economic growth within that economy. Policies of this type may originate with national governments, state governments, or even central banks that set the standard for financial transactions within a given nation or region.

Man climbing a rope
Man climbing a rope

A policy of this type is different from a contractionary policy. With this approach, the goal is still to stabilize an economy that has been adversely affected by a recession that was followed or preceded by a period of inflation. Rather than expanding the money supply as in the expansionary policy, a contractionary strategy would actually limit money supply as a means of bringing the economy into a more desirable state. Both approaches are usually intended for short-term application, although certain elements of each strategy may be incorporated into other financial approaches once the current crisis is successfully addressed.

One type of expansionary policy that is often employed by governments is to make purchases that infuse capital into the economy. This is sometimes accomplished by purchasing treasury bonds, a practice that has been utilized in the United States from time to time. In other situations, tax cuts may be seen as the most effective way of placing more money into the hands of taxpayers and thus encouraging them to purchase more goods and services as a means of stimulating the economy. It is not unusual for a government to work closely with a central bank in order to make adjustments to current interest rates, or to adjust the criteria for lending on mortgages and other types of loans, as a means of moving the economy in the most desirable direction.

It is important to note that any particular expansionary policy may work very well in certain settings, but not be as effective once certain underlying factors affecting the economy have been neutralized. At that point, revisiting the policy and determining if it still has merit is necessary. If so, the policy is likely to continue, possibly with some minor changes to adjust the strategy to fit the current financial state of affairs. Should the expansionary policy be found to no longer adequately address the current economic climate, there is a good chance it will be discontinued and a new strategy developed that will better serve the goal of keeping the economy on an even keel.

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