Question

How would both the Federal Reserve and Government carry out contractionary (Monetary or Fiscal) policy? What event in the overall economy would be the opportune time to use contractionary policy? Why is it difficult for the Government to use contractionary fiscal policy?

Answer 1

Answer - The contractionary monetary policy will be run by the fed in which it can raise the reserve ratio , increase the discounting rate and sell the government securities in the open market to reduce the supply of money in the economy.

In the same way the government can run the contractionary fiscal policy by decreasing the spending and increasing the taxes resulting in the contraction of economy.

These policies will be run when the economy is in the phase of inflation and the real GDP is greater than the potential GDP and the price level are rising due to greater money supply

The problem with the contractionary fiscal policy is the lesser ability to bring about the change in the level of spending. The consumers are reluctant to reduce their consumption levels . Also there are time lags related to implementation and the formulation of the policies which makes it a slower process and has the slower impact upon the economy