In Favour or against expansionary monetary policy:
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There is evidence that unanticipated stimulative, unanticipated contractionary, anticipated stimulative, and anticipated contractionary monetary policy each have statistically significant effects on output, therefore it can be said that because contractionary monetary policy have a impact on output it is more in favour of expansionary monetary policy. A joint communique says that fiscal and monetary policies will stay “expansionary” for as long as needed to reduce the chances of a double-dip recession after the worst financial crisis since World War II.
The United States are holding massive gold reserves. The United States was not constrained from using expansionary policy to offset banking panics, deflation, and declining economic activity. Simulations, based on a model of a large open economy, indicate that expansionary open market operations by the Federal Reserve at two critical junctures (October 1930 to February 1931; September 1931 through January 1932) would have been successful in averting the banking panics that occurred, without endangering convertibility. Indeed had expansionary open market purchases been conducted in 1930, the contraction would not have led to the international crises that followed.
I would even argue, the Great Depression was ignited by the expansionary monetary policy of the Fed, not the restrictive monetary policy of the Fed, that occurred from 1929 to 1932.
There is also a debate that it is possible that expansionary monetary policy may be the reason for the Great depression. Although it was suggested that it was the excessive expansionary monetary policy of the Fed that caused yet another boom-and-bust cycle that spawned the Great Depression, the facts do not bear this out.
But I will say this: Since the recession began in late 2007, the Fed has followed the most expansionary monetary policy in, I think, its history in a situation like this. It has created a trillion dollars in excess reserves. It has done a whole variety of efforts and exertions to bail out companies and so forth in distress. And yet, we have fewer people working today than we did when this effort began.
The reason why Contractionary Monetary Policy may be the better option:
- Contractionary monetary policy causes a decrease in bond prices and an increase in interest rates.
- Higher interest rates lead to lower levels of capital investment.
- The higher interest rates make domestic bonds more attractive, so the demand for domestic bonds rises and the demand for foreign bonds falls.
- The demand for domestic currency rises and the demand for foreign currency falls, causing an increase in the exchange rate. (The value of the domestic currency is now higher relative to foreign currencies)
- A higher exchange rate causes exports to decrease, imports to increase and the balance of trade to decrease.