ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -A contractionary policy is a tool used to reduce government spending or the rate of monetary expansion by a central bank to combat rising inflation. The main contractionary policies employed by the United States include raising interest rates, increasing bank reserve requirements, and selling government securities.

Detailed explanation-2: -The Fed used “open market operations” to pursue that target; that is, by selling (purchasing) securities, the Fed reduced (increased) the supply of bank reserves, thus leading to a higher (lower) federal funds rate.

Detailed explanation-3: -Inflation. Inflation will also affect interest rate levels. The higher the inflation rate, the more interest rates are likely to rise. This occurs because lenders will demand higher interest rates as compensation for the decrease in purchasing power of the money they are paid in the future.

Detailed explanation-4: -“Raising interest rates helps to reduce the overall level of demand and therefore, hopefully, reduces the upward pressure on prices, ” says Gapen. So why might this cause a recession? In the long run, businesses may respond to consumers purchasing fewer goods and services by reducing production, explains Gapen.