DEFINITION of 'Tight Money'

Tight money, also known as dear money, results from a shortage of money when monetary policy decreases money supply and the amount of money banks have to lend, in order to slow down economic activity.

BREAKING DOWN 'Tight Money'

Tight money is usually the result of tight monetary policy that restricts money supply, and reduces the amount of money banks have to lend. It can also be the result of an increased demand to hold money, when the quantity of money remains unchanged.

It is not changing interest rates that define whether money is loose or tight – though capital will generally command a high higher price when money is tight – it is the supply and demand for money. The Federal Reserve changes money supply by selling long-dated government bonds to the banking sector through open market operations, increasing the minimum reserve ratio or changing the discount rate. As a rule, the Fed increases the money supply during downturns and restricts money supply when the economy overheats.

During the financial crisis, when the velocity of money plunged, the Fed engaged in quantitative easing to massively increase the expansion of the monetary base to make sure that the wide money supply did not fall. Now that velocity is returning to normal, the Fed is reversing quantitative easing and sucking all the extra money out of the system, before prices soar. Money will soon be tighter.

When money is tight, businesses have a harder time obtaining loans and households may have difficulty obtaining mortgages. Tight money generally has a negative effect on security prices, in comparison to easy money conditions.

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