Home > Economics FAQs Blogs > What are the objectives of contractionary monetary and fiscal policies?
This question pertains to topics in Macroeconomics, such as Monetary Policy and Fiscal Policy
Contractionary Monetary Policy: This is a form of monetary policy where a central bank seeks to reduce the money supply in the economy. This is usually done by increasing interest rates or selling government bonds.
Contractionary Fiscal Policy: This is a form of fiscal policy where a government seeks to reduce the budget deficit and slowdown the growth of the money supply. This is usually achieved through reducing government spending, increasing taxes, or both.
The primary objective of both contractionary monetary and fiscal policies is to
slow down the economy. This can be necessary when an economy is in an overheated state, experiencing high inflation, or when there is a need to correct asset price bubbles.
Control Inflation: One of the main objectives of contractionary policies is to control inflation. Inflation can erode purchasing power and create uncertainty in the economy. By reducing the money supply, central banks and governments can put downward pressure on prices, helping to control inflation.
Stabilise the Economy: Contractionary policies can also be used to prevent an economy from overheating. If an economy is growing too quickly, it can lead to inflation and create asset bubbles. By slowing down the rate of economic growth, contractionary policies can help stabilise the economy and prevent boom and bust cycles.
Reduce Public Debt: For contractionary fiscal policy specifically, reducing public debt can be a primary objective. By reducing spending and increasing taxes, a government can reduce its budget deficit and start to pay down public debt.
The Bank of England: In November 2017, the Bank of England raised interest rates for the first time in more than a decade from 0.25% to 0.5%. The move was a bid to control rising inflation triggered by the Brexit referendum.
The United States in the 1980s: During the early 1980s, the US Federal Reserve, led by Paul Volcker, dramatically raised interest rates to combat high inflation.
The main objectives of contractionary monetary and fiscal policies are to control inflation, stabilise the economy, and (in the case of fiscal policy) reduce public debt. These policies involve reducing the money supply in the economy, typically through increasing interest rates (monetary policy) or reducing government spending and increasing taxes (fiscal policy). Real-world examples include the Bank of England's rate hike in 2017 and the US Federal Reserve's actions in the 1980s.
