Accommodative Monetary Policy

What Is an Accommodative Monetary Policy?

How an Accommodative Monetary Policy Works

When the economy slows down, the Federal Reserve can implement an accommodative monetary policy to stimulate the economy. It does this by running a succession of decreases in the Federal funds rate, making the cost of borrowing cheaper. The Fed can also allow the money supply to increase or increase the money supply via quantitative easing (QE). Accommodative monetary policy is triggered to encourage more spending from consumers and businesses by making money less expensive to borrow through the lowering of short-term interest rates.

Criticism of Accommodative Monetary Policy 

To avoid inflation, most central banks alternate between the accommodative monetary policy and the tight monetary policy in varying degrees to encourage growth while keeping inflation under control. 

A tight monetary policy is implemented to contract economic growth. Converse to accommodative monetary policy, a tight monetary policy involves increasing interest rates to constrain borrowing and to stimulate savings. As well, the increased money supply can depreciate the currency (exchange rate). 

Example of Accommodative Monetary Policy

The Federal Reserve adopted an accommodative monetary policy during the late stages of the bear market that began in late 2000. When the economy finally showed signs of a rebound, the Fed eased up on the accommodative measures, eventually moving to a tight monetary policy in 2003. Also, to overcome the recession following the 2008 credit crisis, an accommodative monetary policy was implemented and interest rates were cut to 0.5%. To increase the supply of money in the economy, the Federal Reserve can also purchase Treasuries on the open market to infuse capital into a weakening economy.