Monetary Expansion & Monetary Contraction

In the aftermath of the great depression, Mr Hoover wrote a letter to the president elect, Franklin D Roosevelt. In the letter Hoover informed Roosevelt that "it would steady the country greatly if there could be prompt assurance that there will be no tampering or inflation of the currency; that the budget will be unquestionably balanced even if further taxation is necessary; that the government credit will be maintained by refusal to exhaust it in issue of securities"

This policy of Hoover was essentially a rejection of the tools of fiscal and monetary policy that were at his disposal. These tools could of limited and reduced the effects of the Wall Street Crash. As a consequence America sled into a very significant deflationary spiral between 1930-1933.

Ben Bernake, the present chairman of the federal reserve has studied the Great Depression with great depth. One of the main conclusions of his studies, is that this deflationary spiral could of been avoided if the Federal Reserve had not caused a contraction of the money supply. Such a contraction is known as monetary contraction

However, there are some very real dangers of implementing a policy of monetary expansion, the opposite of monetary contraction.

If monetary expansion is two aggressive, this will result in significant inflation. Very strong inflation will destroy people's saving and pension funds, place upward pressure on prices and result in social upheaval. Yet, very strong will inflation would have the positive effect of eroding the real value of debt and liberating the borrower from his repayments. Though such inflation could be seen as a reward for reckless borrowing and raises some questions in relation to moral hazard.

Therefore, a policy of expansionary expansion is as dangerous as a policy of monetary contraction as it can destabilize an economy even further, damage consumer sentiment delay any upturn. Thus, an equilibrium must be found between each policy.