Under what circumstances might the Fed consider contracting the money supply (contractionary monetary policy)?
Under what circumstances might the Fed consider contracting the money supply (contractionary monetary policy)?© SolutionLibrary Inc. solutionlibary.com 9836dcf9d7 https://solutionlibrary.com/business/finance/under-what-circumstances-might-the-fed-consider-contracting-the-money-supply-contractionary-monetary-policy-7gkq
...oney available. The indirect effect of a decrease in the money supply occurs when the policy leads to an increase in interest rates, which lead to lower levels in borrowing by individuals and businesses. When the Federal Reserve System aims to reduce the monetary supply it does so by engaging in contractionary monetary policy. The result of contractionary monetary policy is that aggregate demand is reduced and consequently the equilibrium level of real GDP per year falls. This explains why a reduction in the money supply is a tool used during high-growth periods of the business cycle.
The Fed engages in contractionary policy primarily to close the inflationary gap in an economy. The Fed may fear the onset of higher inflation and in order to combat this fear decreases the money supply. Less money circulating in the economy means the purchasing power of the four sectors considered in the aggregate demand model (household, business, government, and foreign) are restricted. As a result, there is less ability to make purchases at existing price levels. Consumption expenditures, investment expenditures, government purchases, and net exports (see following paragraph for ...