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Contractionary monetary policy is monetary policy that seeks to
reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a finance ministry.
Neoclassical economics and
Keynesian economics economics significantly differ on the effects and effectiveness of monetary policy on influencing the
real economy; there is no clear consensus on how monetary policy effects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates).
Monetary policy relies on a number of tools: monetary base, reserve requirements, discount window lending and
interest rates.
Policy Tools
Monetary Base
Contractionary policy can be implemented by reducing the size of the monetary base. This
directly reduces the total amount of money circulating in the economy.
A central bank can use
open market operations to reduce the monetary base. The central bank would typically sell
Bond (finance) in exchange for hard currency. When the central bank collects this hard currency payment, it removes that amount of currency from the economy, thus contracting the monetary base.
Reserve Requirements
The monetary authority exerts regulatory control over banks. Contractionary policy can be implemented by requiring banks to hold a higher proportion of their total assets in reserve. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By requiring a higher proportion of total assets to be held as liquid cash, a central bank or finance ministrY reduces the availability of loanable funds. This acts as a reduction in the money supply.
Discount Window Lending
Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans the central bank can directly reduce the size of the money supply. By advertising that the discount window will be reduced for future lending, the central bank can also indirectly reduce the money supply by reducing risk-taking by financial institutions.
Interest Rates
The contraction of the monetary supply can be achieved
indirectly by increasing the nominal interest rates.
Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the
federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market.
In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the
money supply, because higher interest rates encourage savings and discourage lending. Both of these effects reduce the size of the money supply.
Monetary Policy and Inflation
Monetary policy can be used to control inflation. Inflation is defined as continuing increases in price levels. Since price level is a monetary variable, monetary policy can affect it. Contractionary monetary policy has the effect of reducing inflation by reducing upward pressure on price levels.
Note that inflation can also be affected by fiscal policy. However, contractionary fiscal policy is often politically unpopular, because it involves spending cuts and tax increases. Thus, politicians favor the use of monetary policy to control inflation.
Monetary Policy and the Real Economy
As noted above, the relationship between monetary policy and the real economy is uncertain. It is important to note that contractionary monetary policy should not be confused with economic contraction (the latter being a reduction in economic output in the real economy).
See also
Contractionary monetary policy is monetary policy that seeks to
reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a
finance ministry.
Neoclassical economics and Keynesian economics economics significantly differ on the effects and effectiveness of monetary policy on influencing the
real economy; there is no clear consensus on how monetary policy effects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates).
Monetary policy relies on a number of tools:
monetary base,
reserve requirements,
discount window lending and
interest rates.
Policy Tools
Monetary Base
Contractionary policy can be implemented by reducing the size of the monetary base. This
directly reduces the total amount of money circulating in the economy.
A central bank can use open market operations to reduce the monetary base. The central bank would typically sell Bond (finance) in exchange for hard currency. When the central bank collects this hard currency payment, it removes that amount of currency from the economy, thus contracting the monetary base.
Reserve Requirements
The monetary authority exerts regulatory control over banks. Contractionary policy can be implemented by requiring banks to hold a higher proportion of their total assets in reserve. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By requiring a higher proportion of total assets to be held as liquid cash, a central bank or finance ministrY reduces the availability of loanable funds. This acts as a reduction in the money supply.
Discount Window Lending
Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans the central bank can directly reduce the size of the money supply. By advertising that the discount window will be reduced for future lending, the central bank can also indirectly reduce the money supply by reducing risk-taking by financial institutions.
Interest Rates
The contraction of the monetary supply can be achieved
indirectly by increasing the nominal interest rates.
Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market.
In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the
money supply, because higher interest rates encourage savings and discourage lending. Both of these effects reduce the size of the money supply.
Monetary Policy and Inflation
Monetary policy can be used to control
inflation. Inflation is defined as continuing increases in price levels. Since price level is a monetary variable, monetary policy can affect it. Contractionary monetary policy has the effect of reducing inflation by reducing upward pressure on price levels.
Note that inflation can also be affected by fiscal policy. However, contractionary fiscal policy is often politically unpopular, because it involves spending cuts and tax increases. Thus, politicians favor the use of monetary policy to control inflation.
Monetary Policy and the Real Economy
As noted above, the relationship between monetary policy and the real economy is uncertain. It is important to note that contractionary monetary policy should not be confused with economic contraction (the latter being a reduction in economic output in the real economy).
See also
Contractionary monetary policy - Wikipedia, the free encyclopedia
Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a ...
Expansionary Monetary Policy vs. Contractionary Monetary Policy
I'm having a little trouble trying to understand expansionary monetary policies and contractionary monetary policies. Can you help explain what impact expansionary monetary ...
contractionary monetary policy definition - Dictionary - MSN Encarta
con·trac·tion·ar·y mon·e·tar·y pol·i·cy (plural con·trac·tion·ar·y mon·e·tar·y pol·i·cies) noun : Definition: stabilization by decreasing money supply: a ...
Category:Monetary policy - Wikipedia, the free encyclopedia
Capital control; Contractionary monetary policy; Cross of Gold speech; D. Discount rate; Dollar hegemony ... Retrieved from "http://en.wikipedia.org/wiki/Category:Monetary_policy "
Contractionary Monetary Policy - Definition of Contractionary Monetary ...
Definition of contractionary monetary policy and how the Fed uses contractionary monetary policy to avoid inflation.
Contractionary fiscal policy - Hutchinson encyclopedia article about ...
US fiscal policy has been directed largely at achieving or maintaining full ... Contractionary monetary policy Contractions Contractions Contractions Contractions
Contractionary fiscal policy definition of Contractionary fiscal ...
fiscal policy. Measures employed by governments to stabilize the economy ... Contractionary monetary policy Contractions Contractions Contractions Contractions
SparkNotes: Tax and Fiscal Policy: Monetary Policy
Again, some Fed contractionary monetary policy--like increasing the reserve requirement and increasing the federal funds interest rate--directly affects the interest rate.
AmosWEB is Economics: GLOSS*arama
CONTRACTIONARY MONETARY POLICY: A form of stabilization policy consisting of a decrease in the amount of money in circulation (that is, the money supply).
Contractionary fiscal policy financial definition of Contractionary ...
Fiscal policy. Government spending and taxing for the specific purpose of ... Contractionary monetary policy Contractions Contractions Contractions Contractions
