When the economy is faced with recession or involuntary cyclical unemployment, which comes due to fall in aggregate demand, the central bank intervenes to cure such a situation. Central bank takes steps to expand the money supply in the economy and lower the rate of interest with a view to increase the aggregate demand that will help in stimulating the economy. The following three monetary policy measures are adopted as a part of an expansionary monetary policy to measures are adopted to cure recession and to establish the equilibrium of national increase at full employment level of output.
(i) Release marketplace process: The central bank undertakes open market operations and buys securities in the open market. Buying to securities by the central bank, from the public, chiefly from commercial banks will lead to the increase in reserves of the banks or amount of currency with the general public. With greater reserves, commercial banks can issue more credit to the investors and businessmen for undertaking more investment. More private investment will cause aggregate demand curve to shift upward. Thus buying of securities will have an expansionary effect.
(ii) Reduce in Bank Rate: The Central Bank may lower the bank rate or what is also called discount rate, which is the rate of interest charged by the central bank of country on its loans to commercial banks. At a lower bank rate, the commercial banks will be induced to borrow more from the central bank and will be able to issue more credit at the lower rate of interest to businessmen and investors. This will not only make credit cheaper but also increase the availability of credit or money supply in the economy. The expansion in credit or money supply will increase the investment demand, which will tend to raise aggregate output and income.
(iii) Decrease of Cash Reserve Ratio (CRR): Thirdly, the central bank may reduce the Cash Reserve Ratio (CRR) to be kept by the commercial banks. In countries like India, this is a more effective and direct way of expanding credit and increasing money supply in the economy by the central bank. With lower reserve requirements, a large amount of funds is released for providing loans to businessmen and investors. As a result, credit expands and investment increases in the economy, which has an expansionary effect on output and employment.