Expansionary Policy

Definition

Expansionary policy refers to the set of economic measures taken by a government or central bank to stimulate economic growth and increase the level of employment. This policy aims to expand the money supply, reduce interest rates, and encourage consumer spending and investment.

5 Must Know Facts For Your Next Test

1. Expansionary policy is typically used to combat economic recessions and high unemployment rates.
2. The primary tools of expansionary policy include lowering interest rates, increasing government spending, and reducing taxes.
3. Expansionary policy aims to stimulate aggregate demand, which can lead to higher inflation in the short run.
4. The Phillips Curve suggests that there is a tradeoff between inflation and unemployment, and expansionary policy can help reduce unemployment at the cost of higher inflation.
5. Expansionary policy can also lead to a weaker currency, which can boost exports and improve the country's trade balance.

Review Questions

• Explain how expansionary policy can be used to address high unemployment rates.
  • Expansionary policy is designed to stimulate economic growth and increase the level of employment. By lowering interest rates, increasing government spending, and reducing taxes, expansionary policy aims to boost aggregate demand in the economy. This can lead to higher consumer spending, business investment, and overall economic activity, which in turn can create more job opportunities and reduce unemployment rates.
• Describe the relationship between expansionary policy and the Phillips Curve.
  • The Phillips Curve suggests that there is a tradeoff between inflation and unemployment. Expansionary policy, which aims to stimulate economic growth, can help reduce unemployment in the short run. However, this increased economic activity can also lead to higher inflation, as the increased demand for goods and services puts upward pressure on prices. The Phillips Curve illustrates this inverse relationship between inflation and unemployment, and expansionary policy can be used to move along the curve, trading off higher inflation for lower unemployment.
• Analyze how expansionary policy can impact a country's trade balance.
  • Expansionary policy, which typically involves a weakening of the domestic currency, can improve a country's trade balance. A weaker currency makes exports more affordable for foreign buyers, which can boost demand for the country's exports. At the same time, imports become more expensive for domestic consumers, which can discourage imports and improve the trade balance. This can help to narrow a country's trade deficit or even create a trade surplus, as the increased demand for exports and reduced demand for imports leads to a more favorable balance of trade.

Related terms

Monetary Policy:

Monetary policy is the actions taken by a central bank, such as the Federal Reserve, to influence the money supply and interest rates in order to achieve economic objectives.

Fiscal Policy:

Fiscal policy refers to the government's use of taxation and spending to influence the economy, including the level of economic activity, employment, inflation, and the distribution of income.

Phillips Curve:

The Phillips Curve is an economic model that shows the relationship between the rate of unemployment and the rate of inflation in an economy.