Expansionary monetary policy is achieved when the Fed increases the economy’s money supply to promote spending and borrowing. This causes a decrease in interest rates which can stimulate the economy during periods of recession. Long-term expansionary monetary policy can lead to inflation. To combat inflation, the Fed will implement a restrictive monetary policy. The contractionary monetary policy increases interest rates, which reduces borrowing and promotes saving (LinkedIn, 2015). In my opinion, the Fed should try to find a balance between expansionary and contractionary monetary policy. The economy has stabilized since the 2009 recession but quickly increasing interest rates could negate any progress that has been made.
Increasing the money supply will devalue the currency since there will be more of it available. Interest rates will decrease and inflation will start to increase (LinkedIn, 2015). This is due to the value of the currency being decreased and more money being required to buy the same item. The Fed may avoid this approach because of the long-term impact it will have on the economy and value of the USD.
If a currency is backed solely by the faith in government, then the best way to maintain stability is to simply avoid policy and action that would erode this faith. The Fed can build trust in a currency by enacting policy that strengthens the economy and provides a level of predictability. Drastic, unexpected changes could erode faith in the USD which would lower its value.