Contractionary policy

Examples of Contractionary policy in the following topics:

• How Fiscal Policy Relates to the AD-AS Model

  • Expansionary policy shifts the aggregate demand curve to the right, while contractionary policy shifts it to the left.
  • A contractionary fiscal policy is implemented when there is demand-pull inflation.
  • In pursuing contractionary fiscal policy the government can decrease its spending, raise taxes, or pursue a combination of the two.
  • Contractionary fiscal policy shifts the AD curve to the left.
  • Expansionary policy shifts the AD curve to the right, while contractionary policy shifts it to the left.

• Introduction to Monetary Policy

  • 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.
  • Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values, or to cool an overheating economy.
  • 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.

• Managing the Business Cycle

  • 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.
  • Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions.
  • 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

• 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.
  • In a contractionary policy regime, the Fed would increase the reserve requirement, thereby effectively restricting the funds that banks have available for loans.
  • 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.

• Limits of Fiscal Policy

  • Two key limits of fiscal policy are coordination with the nation's monetary policy and differing political viewpoints.
  • While fiscal policy can be a powerful tool for influencing the economy, there are limits in how effective these policies are.
  • 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.

• Interest Rate Levels

  • Monetary policies are referred to as either expansionary or contractionary.
  • An expansionary policy increases the total supply of money in the economy more rapidly than usual.
  • Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.
  • Contractionary policy increases interest rate levels by expanding the money supply more slowly than usual or even shrinking it.
  • This change in fiscal policy shifts equilibrium in the goods market.

• Expansionary Versus Contractionary Fiscal Policy

  • Keynes advocated counter-cyclical fiscal policies (policies that acted against the tide of the business cycle).
  • This is known as expansionary fiscal policy.
  • Conversely, in times of economic expansion, the government can adopt a contractionary policy, decreasing spending, which decreases aggregate demand and the real GDP, resulting in a decrease in prices.
  • The effects of fiscal policy can be limited by crowding out.
  • Keynesian economists advocate counter-cyclical fiscal policies.

• Monetary Policy

  • It is referred to as either being expansionary or contractionary.
  • A contractionary policy expands the money supply more slowly than usual or even shrinks it.
  • Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.
  • Monetary policy differs from fiscal policy.
  • A policy is referred to as "contractionary" if it reduces the size of the money supply, increases the money supply slowly, or if it raises the interest rate.

• 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.
  • Expansionary policy attempts to promote aggregate demand growth.
  • Monetary policy focuses on the first two elements.
  • A central bank can enact an expansionary monetary policy several ways.