Definition of a Restrictive Monetary Policy

Restrictive monetary policy tightens credit, which reduces the money supply.

When monetary policy makers such as the U.S. Federal Reserve take actions to reduce a nation's money supply, they are engaging in restrictive monetary policy. They usually take these actions to contain or reduce inflation in the economy.

Prevention/Solution

Inflation harms the economy by raising the prices consumers and businesses pay for goods and services. Central banks, which make monetary policy, enact restrictive policy to reduce inflation.

Types

Restrictive monetary policy actions include selling government bonds, increasing banks' reserve requirements, and increasing the discount rate.

Effects

Restrictive monetary policy actions reduce the money supply, in part by making it harder to borrow. This eases inflationary pressures by lowering the amount of money available for spending.

Benefits

By reducing--or, at least, containing--inflation, restrictive monetary policy helps ensure stability in the nation's price system, one of the chief goals of monetary policy.

Considerations

Central banks must carefully weigh economic conditions, as measured by data on retail and wholesale prices, unemployment rates, gross domestic product, and other measures, before enacting monetary policy. Overly restrictive measures could hamper consumption and investment.

References

• Board of Governors of the Federal Reserve System

Resources

• Council for Economic Education: More About Monetary Policy