Q. What do you mean by the tightening of monetary policy? Why it is used? Explain.

“The tightening of monetary policy” is a contractionary policy that a central bank uses to reduce inflation. It is usually implemented when inflation is rising rapidly.

How it works?

• Interest rates: The central bank increases interest rates.
• Money supply: The central bank reduces the money supply.
• Reserve requirements: The central bank raises the reserve requirements of banks.
• Government securities: The central bank sells government securities.

Why it’s used?

• To slow down overheated economic growth.
• To reduce the demand for money.
• To limit the pace of economic expansion.
• To reduce inflation.

How it works?

• A higher interest rate may help control high inflation.
• Access to credit becomes more expensive, which reduces consumption and investment.
• The cost of market-based debt increases more quickly than that of bank loans.
• A reduction in the money supply can help to slow or keep the domestic currency from inflation.

In essence, tightening monetary policy is used to maintain economic stability and prevent the economy from experiencing extreme fluctuations in growth and inflation. It’s a balancing act to ensure that the economy grows at a sustainable rate without causing too much inflation or leading to a market bubble.