Question

Which kind of monetary policy would you expect in response to recession: expansionary or contractionary? Why?

Short answer

In the event of a recession, expansionary monetary policy is the most suitable reaction.

Step-by-step solution

Recession

A recession is defined as a significant slowdown or contraction in economic activity. A recession is usually preceded by a significant drop in consumer expenditure. Such a slowdown in economic activity can endure for several quarters, thereby halting an economy's growth. Economic statistics such as GDP, profitability, employment, and so on.

Expansionary monetary policy 

Expansionary monetary policy works by increasing money supply more quickly than usual or lowering short-term interest rates. It aims to boost corporate investment and consumer spending by injecting money into the economy, either directly or through greater financing to businesses and consumers. Tax cuts, transfer payments, rebates, and increased government investment on infrastructure improvements are all part of the expansionary monetary policy.

Contractionary monetary policy 

In order to lower the money supply, a contractionary monetary policy would raise interest rates to discourage borrowing and cut government spending to enhance money availability. Higher interest rates, lower income, and a drop in demand, production, and employment result as a result of this.

Conclusion

When an economy is in a slump, expansionary monetary policy is the best option. In theory, this policy has the potential to support and restore the nation's economy to its potential GDP. It achieves this by lowering interest rates, which encourages investment and expenditure.