What Is a Tight Monetary Policy?
Tight monetary policy refers to actions by a central bank to restrict the supply of money or credit to a national banking system. Tight money can adversely affect business and investments.
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History
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Monetary policy in a national economy evolved as finance increased its proportion of national income and government-owned central banks became the arbiters of money supply. This all largely took place in the 20th century.
Function
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Central banks, such as the Federal Reserve System in the U.S. or the Bank of England in the UK, can control how much money flows into the banking system. They do this primarily by raising or lowering interest rates for borrowing from the central bank.
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Reason
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A core duty of central banks is to preserve the value of the currency. If inflation is devaluing a currency, the central bank will react by raising interest rates. This will slow the increase of money supply or credit, which in turn slows down the rate of price increases. This is tight monetary policy.
Method
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Besides raising and lowering interest rates, a central bank can inject money into the economy by buying securities or other assets. It can drain money from the economy by selling securities or other assets. The latter is another tool in executing a tight monetary policy. A third way is to raise or lower reserve requirements for banks, which lessens or increases their ability to lend.
Economic impact
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Tight monetary policy can make credit very expensive, which dampens economic activity. A recent example was when the oil crisis of 1973-74 created double-digit inflation and the Federal Reserve raised short-term borrowing rates accordingly, plunging the U.S. economy into a recession.
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