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Accommodative Monetary Policy

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An accommodative monetary policy is an effort by the U.S. Federal Reserve Board or another central bank to stimulate its nation's economy. Lower interest rates are the hallmark of an accommodative monetary policy. An interest rate is the cost of borrowing money; when money becomes cheaper through an accommodative monetary policy, it costs businesses and consumers less to borrow, thus they spend more. The additional spending of an accommodative monetary policy has a multiplier effect, and business picks up throughout the economy. At some point under an accommodative monetary policy, the economy tends to overheat. In other words, an accommodative monetary policy results in too much money chasing too few goods, or inflation. At that point, an accommodative monetary policy loses favor, as consumers and producers watch prices rise. The Fed then changes course from an accommodative monetary policy to "tighter money," i.e. it takes steps to raise interest rates, tamp down business activity, and reduce inflation. A reasonably accommodative monetary policy is liked by investors in equities, because more business activity usually produces greater earnings and higher stock prices.



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