ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -In order to reduce the money supply, the central bank can opt to increase the cost of short-term debt by increasing the short-term interest rate. The increase in interest rates will also affect consumers and businesses in the economy as commercial banks will raise the interest rates they charge their clients.

Detailed explanation-2: -Why does contractionary monetary policy cause interest rates to rise? Contractionary policy reduces the amount of loanable funds in the economy. As with all goods, greater scarcity leads a greater price, so the interest rate, or the price of borrowing money, rises.

Detailed explanation-3: -A contractionary monetary policy, also called a tight monetary policy, reduces the quantity of money and credit below what it otherwise would have been and raises interest rates, seeking to hold down inflation.

Detailed explanation-4: -What Are the Effects of Contractionary Policy? A contractionary policy often results in the tightening of credit through increased interest rates, increased unemployment, reduced business investment, and reduced consumer spending.

Detailed explanation-5: -The central bank tightens policy or makes money tight by raising short-term interest rates through policy changes to the discount rate and federal funds rate. Boosting interest rates increases the cost of borrowing and effectively reduces its attractiveness.