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Definition of 'Contractionary Policy'
A type of policy that is used as a macroeconomic tool by the country's central bank or finance ministry to slow down an economy. Contractionary policies are enacted by a government to reduce the money supply and ultimately the spending in a country.
This is done primarily through:
1. Increasing interest rates
2. Increasing reserve requirements
3. Reducing the money supply, directly or indirectly
This tool is used during high-growth periods of the business cycle, but does not have an immediate effect.
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Investopedia explains 'Contractionary Policy'
When both spending and the availability of money are high, prices start to rise - this is known as inflation. When a country is experiencing higher-than-anticipated inflation, the government might step in with a contractionary policy to try to slow down the economy. Their goal is to reduce spending by making it less attractive to acquire loans or by taking currency out of circulation, and thus reduce inflation. The effectiveness of these policies vary.
1. Increasing the interest rate at which the Federal Reserve lends will also increase the rates at which banks lend. When rates are higher, it is more expensive for individuals to obtain loans; this reduces spending.
2. Banks are required to keep a reserve of cash to meet withdrawal demands. If the reserve requirements are increased, there is less money for banks to lend out. Thus there is a lower money supply.
3. Central banks can borrow money from institutions or individuals in the form of bonds. If the interest paid on these bonds is increased, more investors will buy them. This will take money out of circulation. Central banks can also reduce the amount of money they lend out or call in existing debts to reduce the money supply.
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Search results for 'Contractionary Policy'
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http://www.investopedia.com/exam-guide/finra-series-6/economic-factors/fiscal-policy.asp
... Contractionary fiscal policy occurs when the business cycle is near its peak,
businesses are at full capacity, unemployment is low and business profits are high ...
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http://www.investopedia.com/university/macroeconomics/macroeconomics10.asp
... Expansionary fiscal policy features increased government spending and/or decreases
in the tax rates, while contractionary policy is the opposite (lower ...
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http://www.investopedia.com/articles/stocks/08/monetary-policy.asp
... When Fed policy is contractionary, decrease equity exposure and invest in economically
less sensitive sectors, such as consumer staples and healthcare. ...
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http://www.investopedia.com/articles/economics/09/debt-monetization.asp
... Fiscal policy is the tax and spending policy of current presidential ... During
contractionary cycles and low interest rate environments, money growth and debt ...
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http://www.investopedia.com/articles/forex/08/top-8-currencies-to-know.asp
... The release of this letter tends to be a harbinger to markets, as it increases
the probability of contractionary monetary policy. ...
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