Monetary policy involves how the monetary authority controls the money supply through targeting interest rates in order to promote economic stability, and growth. Therefore, when a central bank implements a contractionary monetary policy, it monitors the effect on the economy very closely and adjusts interest rates on a periodic basis. Discouraging consumer spending by increasing interest rates helps in combating the monetary policy inflation as it results in reduced demand but can also lead to increased unemployment due to less This has been a guide to Contractionary Monetary Policy.
Since Estrovia has inflation rate of 9% as compared with average of 4%, her central bank should implement a contractionary monetary policy to lower the inflation rate, otherwise the economy will heat up and hit a severe recession. This helped to control the inflation rate, which dropped to 3.2% in 1983.The central bank of a country can implement a contractionary monetary policy by raising interest rates and decreasing the money supply.

Based on this newspaper headline, should the FOMC pursue expansionary or contractionary policy? The main goals of monetary policy include stabilizing prices and maintaining low levels of unemployment. Further, the trend rate also changes over time as the structural condition of the economy changes and such structural changes in the economy reduce the trend growth rate of the economy. Central Bank influences interest rates by expanding or contraction of the monetary base, which is the currency in circulation and banks’ reserves (These are the three main tools that are used by Central Bank to implement the Contractionary Monetary Policy:Monetary Policy is often adjusted to reflect the source of inflation. dyckerhoff.com.

The opposite of expansionary monetary policy is contractionary monetary policy, which maintains short-term interest rates higher than usual or which slows the rate of growth in the money supply or even shrinks it.
(Structural condition refers to changes in the saving and investment pattern in an economy, for instance, consumer shift from the use of heavy debt to increase saving and reduction in consumption).Where Neutral Interest Rate is the growth rate of the money supply that neither increases nor decreases the economic growth rate.When the policy rate is above the neutral interest rate, the monetary policy is said to be a Contractionary Monetary Policy.

Contractionary Monetary Policy is an appropriate response to combat inflation if inflation is above the target inflation (determined by Central Bank) caused due to higher The idea behind implementing a contractionary monetary policy is to make the opportunity cost of holding funds high so that people save more and spend less. It includes two policies namely; expansionary policy and contractionary policy. The Federal Funds Rate was hiked to 20%. Expansionary monetary policy usually diminishes the value of the currency relative to other currencies (the exchange rate). This action changes the reserve amount the banks have on hand. This can help to lower inflation but could also lead to a slowdown in economic activity.Bryce Welker is a regular contributor to Forbes, Inc.com, and Business Insider. This pushes the demand and the cost of production to desirable levels. Expansionary Contractionary . If applied, it reduces the size of money supply in the economy, thereby raising the interest rates.

Let’s understand Contractionary Monetary Policy in detail.It is a macroeconomic tool that is designed to combat monetary policy inflation which results from an expanding money supply in the economy, unreasonable asset valuation, and unsustainable speculation in the Stock Market.Initially a contractionary monetary policy results in tightening of credit in the economy, increase unemployment, reduced borrowing by the private sector and reduced consumer spending resulting in an overall reduction in Monetary Authorities measure an economy’s long-term sustainable real growth rate also called the Real Trend rate. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our IB Excel Templates, Accounting, Valuation, Financial Modeling, Video TutorialsIB Excel Templates, Accounting, Valuation, Financial Modeling, Video TutorialsAll in One Financial Analyst Bundle (250+ Courses, 40+ Projects)250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion However, a contractionary monetary policy could have unintended consequences. This leads to a reduction in the rate of inflation.However, a contractionary monetary policy could have unintended consequences. Paul Volcker became Fed Chair in 1979. For example, the Federal Reserve’s target inflation rate is 2% per year. By setting the policy rate above the neutral interest rate, the growth rate of the money supply is decreased. You may learn more about Economics from the following articles –Copyright © 2020. This reduces the rate of inflation. A higher reserve means banks can lend less. It may slow the economy too quickly and this could lead to a recession. In fact, in 1980 the inflation rate reached a level of 13.5%.How were runaway inflation rates brought under control? How exactly does this happen? dyckerhoff.com. Economic Growth. He imposed a contractionary monetary policy.

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