Question

How should the government change its Monetary and Fiscal Policy during an inflation?

Answer 1

Contractionary Monetary Policy

This is a type of monetary policy used by the central bank of a country to reduce monetary infaltion in order to fight inflation.

The contractionary monetary policy tools include:

• The central bank increases the short-term interest rates to increase the cost of borrowing and increase savings.
• The central bank raises the reserve requirements for commercial banks in order to reduce the money supply in the economy.
• The central bank expands its open market operations by selling large amounts of government securities in order to reduce money circulation in the economy.

Contractionary Fiscal Policy

This is a form of fiscal policy where the government increases taxes and cuts on its expenditure to reduce aggregate demand. Consequently reducing the money supply in the economy.

Contractionary policy is a form of policy implemented by the policy makers to constrain aggregate spending in an economy.