Advantages and Disadvantages of Contractionary Monetary Policy

Topics: Inflation, Monetary policy, Keynesian economics Pages: 2 (438 words) Published: April 25, 2013

Fiscal policies and monetary policies are the two means implemented by the government to deliver its macroeconomic objectives. Fiscal policies are more related to increasing and decreasing the aggregate demand through tax rates and government spending. On the other hand, monetary policies are the actions of the central banks that determine the size and rate of money circulating in the economy. Economists say that there is no interaction between fiscal and monetary policies since they will only interact on influencing the final objectives which is to have stable price and low inflation rate.

Contractionary monetary policy is one of the policies used by the monetary authorities to combat inflation. Inflation , according to Merriam-Webster Dictionary, is a continuing rise in the general price level usually contributed to an increase in the volume of money and credit relative to available goods and services. Monetary authorities such as the Central Bank can raise interest rates which will make it harder for consumers and businesses to borrow money and persuade them not to spend money. Slowing inflation by deterring economic growth cools off the booming economy and brings down the aggregate demand and the price will go down with this demand. As inflation causes increasing prices, pruchasing power of the people decreases. A monetary contraction stabilizes prices of goods in the market as the inflation rate go down. This will increase the confidence of the people in the economy and it will urge them to have sound spending pattern.

Amidst these advantages, there are some disadvantages that a contractionary monetary policy holds. One of these is that it slows down the production. It is because there is a reduced demand for products, companies will try to decrease the number of goods they make. They will also try to cease its planned expansions. If applied during recession periods, it can...

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