What is the effect of an expansionary monetary policy on interest rates?

An expansionary monetary policy is implemented by a central bank to stimulate the economy, particularly during periods of economic downturn or recession. This policy typically involves actions such as lowering the policy interest rate, purchasing government securities, or increasing the money supply.

When the central bank lowers interest rates, it makes borrowing cheaper. This incentivizes individuals and businesses to take out loans for consumption and investment, which can boost economic activity. As a result, the increased availability of money leads to a decrease in overall interest rates in the economy.

Furthermore, by conducting open market operations and buying government bonds, the central bank injects liquidity into the financial system, which further contributes to lowering interest rates. The relationship between an expansionary monetary policy and interest rates is fundamental in macroeconomic theory, as it outlines how monetary authorities can influence economic growth through interest rate adjustments.

In contrast, an increase in interest rates typically follows a contractionary monetary policy aimed at reducing inflation or overheating in the economy. Unchanged rates would suggest that the policy is neutral or that the economic conditions are stable; dramatic fluctuations in interest rates might happen due to external shocks rather than a direct consequence of a consistent expansionary monetary stance. Thus, the decrease in interest rates during an expansionary monetary policy is a