EXPANSIONARY MONEY POLICY When the central bank increases money supply through the use of expansionary monetary

policy, interest rates will fall. When interest rates fall, cost of borrowing falls. Thus more people would want to borrow money for consumption of big ticket goods and more firms would want to borrow money to invest. Thus C and I components of the aggregate demand would increase, causing AD to increase. When AD increases, the national income of an economy also increases via the multiplier effect. However, when i/r increases, there may be an outflow of money from the economy. Hot money refers to short term capital in search of high returns and monetary stability. This is due to investors not wanted to invest due to lowered expected returns due to low interest rates. When money supply increases due to the policy, coupled with the outflow of hot money, the countrys currency will depreciate as there is a lack of demand for domestic currency. When the currency depreciates, the price of imports would rise. Assuming that exports are imports are good substitutes, consumers would switch to consuming domestically produced goods. Thus the demand for imports falls. When the currency depreciates, the price of exports become lower. Thus more foreign economies would want to trade with us due to cheaper prices. Thus the export competitiveness improves. Assuming the demand for exports and imports are both elastic, export revenue increases while import revenue falls. (X-M) increases, causing aggregate demand to increase too. When interest rates fall, it will cause AD to increase from AD1 to AD2. Thus at the prevailing price of P1, the aggregate demand for goods exceeds the aggregate supply. Thus there is a shortage at E1. Thus there is an upward pressure on price. As AD increases, stocks decrease too. So in order to replenish the loss, producers produce more goods and services. This causes an increase in quantity supplied. Thus there is a movement up the AS curve. At the same time, due to higher prices, consumers and economic agents will cut back on spending. Thus there is movement up the AD2 curve. This adjustment process will continue until there is no more shortage in goods and services. At the new equilibrium, prices increase from p1 to p2 and national output increases from y1 to y2.

However, there are limitations to this policy. Depending on the size of a country, the multiplier effect might not be very great. As such, the increase in C and I components of AD might not be very great. Also, since the country is in a recession, even if i/r falls, not many people would want to invest

as they are more like to save. Thus there is investment inelasticity. Thus investments may not increase. Varying from countries, like Singapore, the main engine of growth for the economy is trade. Thus C and I components are small as compared to (X-M). As such, the impact of this policy would be quite minimal in trying to correct recession. Also, if this policy is sustained, it may result in inflationary pressures. This is due to the persistent increase in the GPL due to increase in AD when I/R fell. Thus in the long run, this policy may result in inflation.