Final answer:
In expansionary monetary policy, the central bank increases the supply of money and loanable funds, which lowers interest rates and stimulates borrowing. However, there are situations when this policy may not work well, such as when banks hold excess reserves or during a deep recession.
Step-by-step explanation:
In expansionary monetary policy, the central bank causes the supply of money and loanable funds to increase, which lowers the interest rate, stimulating additional borrowing for investment and consumption, and shifting aggregate demand right. The result is a higher price level and, at least in the short run, higher real GDP.
However, there are situations when expansionary monetary policy may not work well. For instance, when banks choose to hold excess reserves above the legally required level, the central bank cannot force individual banks to make loans. Additionally, during a deep recession, businesses and consumers may be reluctant to borrow money due to the insecurity of sales and jobs. As a result, expansionary monetary policy may have little effect on the price level or real GDP in these situations.