Question

The Fed has several tools they can use to exercise their monetary policies. Describe two ways the Fed can do to exercise a tight money policy! Describe the kind of economic situation in which such a tight money policy would be appropriate for the economy! Explain why!

Answer 1

The tight monetary or contractionary policy required in the case of inflation in the economy. Under the tight monetary policy, the money supply expands more slowly than usual or even shrinks. Tight monetary policy is intended to slow inflation in order to avoid the resulting distortion and deterioration of asset values.

The objectives of Tight monetary policy

-constricts spending,

-curbs inflation

-reduce borrowing

-slows business expansion

-decrease consumer spending and business production

Tools of tight monetary policy:

1-Increase in Interest rate: Tight monetary policy as central banks seek to reduce the money supply by restricting credit by increasing interest rate. Interest rates are raised this reduces cash in the economy. This has the opposite effect on both production and consumption. This reduces the speed of the economy.

2-Open Market Treasury Sales: The Fed (Central bank) can also tighten monetary policy by restricting the supply of money. To do this, they can print less money or sell long-dated government bonds to the banking sector. By selling bonds, banks see a reduction in liquidity and therefore reduce lending.

The economic situation in which tight monetary policy needed:

The high rate of inflation: Tight monetary policy will typically be chosen when inflation is

above the inflation target (of 2%) or policymakers fear inflation is likely to rise without

a tightening of monetary policy. For example, in the early 1980s, the British government increased interest rates in response to higher inflation. This caused inflation to peak in 1980 and then fall.

for economic stability: in 2018, As per the report of Dhaka Tribune, Bangladesh Bank (central bank of Bangladesh)announced plans to issue a tight monetary policy, in an effort to control the supply of credits and inflation and ultimately maintain economic stability in the country. While still under review, the central bank also aims to slash the advances-deposit ratio (ADR) to keep the private sector’s credit growth rates within stipulated limits.