contractionary monetary policy

Examples of contractionary monetary policy in the following topics:

• Introduction to Monetary Policy

  • Monetary policy is the process by which a monetary authority controls the money supply, often to produce stable prices and low unemployment.
  • Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it.
  • Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing.
  • By contrast, a monetary authority will pursue a contractionary monetary policy when it considers inflation a threat.
  • Thus, contractionary monetary policy causes aggregate demand to fall, thereby reducing the rate of inflation. .

• The Effect of Restrictive Monetary Policy

  • Monetary policy is can be classified as expansionary or restrictive (also called contractionary).
  • Contractionary policy attempts to slow aggregate demand growth.
  • A central bank can enact a contractionary monetary policy several ways.
  • Another way to enact a contractionary monetary policy is to decrease the amount of discount window lending.
  • A final method of enacting a contractionary monetary policy is by increasing the reserve requirement.

• Executing Restrictive Monetary Policy

  • The central bank may initiate a contractionary or restrictive monetary policy to slow growth.
  • An active contractionary policy restricts the size of the money supply, increasing the interest rate.
  • Restrictive monetary policy will seek to increase the fed funds target rate.
  • In a contractionary policy regime, the Fed sells government securities from a bank in exchange for cash.
  • Contractionary monetary policy results in a reduction in the money supply, depicted as a leftward shift, which results in an increase in interest rates as well as a decrease in the quantity of loanable funds.

• The Impact of Monetary Policy on Aggregate Demand, Prices, and Real GDP

  • This creates a relationship between monetary policy and aggregate demand.
  • Contractionary monetary policy decreases the money supply in an economy .
  • Expansionary monetary policy increases the money supply in an economy.
  • This graph shows the effect of expansionary monetary policy, which shifts aggregate demand (AD) to the right.

• Managing the Business Cycle

  • When the economy is not at a steady state, the government and monetary authorities have policy mechanisms to move the economy back to consistent growth.
  • If the economy needs to be slowed, these policies are referred to as contractionary and if the economy needs to be stimulated the policy prescription is expansionary.
  • Contractionary fiscal policy is opposite of the action taken in an expansionary purpose, and occurs when government spending is lower than tax revenue.
  • Similarly, contractionary monetary policy is the opposite of expansionary monetary policy and occurs when the supply of loanable funds is limited, to reduce the access and availability to relatively inexpensive credit.
  • Identify how changes in monetary and fiscal policy can manage the business cycle, and why that is desirable

• The Effect of Expansionary Monetary Policy

  • Monetary policy is referred to as either being expansionary or contractionary.
  • Expansionary policy seeks to accelerate economic growth, while contractionary policy seeks to restrict it.
  • Monetary policy focuses on the first two elements.
  • A central bank can enact an expansionary monetary policy several ways.
  • Another method of enacting a expansionary monetary policy is by decreasing the reserve requirement.

• Limitations of Monetary Policy

  • Monetary policy can influence an economy but it cannot control it directly.
  • There are limits as to what monetary policy can accomplish.
  • Below are some of the factors that can make monetary policy less effective.
  • The other group may believe the economy is booming and pursue a contractionary policy.
  • If monetary policy is too contractionary for too long, deflation could set in.

• Limits of Fiscal Policy

  • Two key limits of fiscal policy are coordination with the nation's monetary policy and differing political viewpoints.
  • Fiscal policy and monetary policy are the two primary tools used by the State to achieve its macroeconomic objectives.
  • Policy makers are viewed to interact as strategic substitutes when one policy maker's expansionary (contractionary) policies are countered by another policy maker's contractionary (expansionary) policies.
  • If they behave as strategic complements,then an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of other.
  • Also, it is worthy to note that fiscal and monetary policies interact only to the extent of influencing the final objective.

• The Taylor Rule

  • Taylor's rule was designed to provide monetary policy guidance for how a central bank should set short-term interest rates.
  • It was designed to provide monetary policy guidance for the Federal Reserve.
  • The Taylor rule advocates setting interest rates relatively high (contractionary policy) when inflation is high or when the employment rate exceeds the economy's full employment level.
  • The Taylor rule fairly accurately demonstrates how monetary policy has been conducted under recent leaders of the Federal Reserve, such as Volker and Greenspan.
  • Stanford University Professor John Taylor is the creator of the Taylor Rule, a monetary policy instrument developed to promote stable economic growth and limit short-run economic disruption related to inflation.

• The Demand for Money

  • Interest-rate targets are a tool of monetary policy.
  • Monetary policy also impacts the money supply.
  • Expansionary policy increases the total supply of money in the economy more rapidly than usual and contractionary policy expands the supply of money more slowly than normal.
  • Expansionary policy is used to combat unemployment, while contractionary is used to slow inflation.
  • The Federal Reserve implements monetary policy through the federal funds rate.