If a central bank decides that it needs to reduce both aggregate demand and the money supply, it will implement a tight monetary policy.
What happens if the central bank reduces the money supply?
If the Fed wants to reduce the money supply, it sells bonds from its account, bringing in cash and removing money from the economy. The federal funds rate adjustment is a highly anticipated economic event.
The central bank uses contractionary monetary policy to reduce the supply of money and credit in the economy, which raises interest rates, discourages borrowing for investment and consumption, and shifts aggregate demand to the left.
Therefore, A contractionary monetary policy is implemented when a central bank reduces the money supply while increasing interest rates.
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