ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -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. There is commonly an overall reduction in the gross domestic product (GDP).

Detailed explanation-2: -A contractionary monetary policy will shift the supply of loanable funds to the left from the original supply curve (S0) to the new supply (S2), and raise the interest rate from 8% to 10%.

Detailed explanation-3: -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-4: -Contractionary monetary policy aims to slow down economic growth or even contract the economy in order to keep inflation at bay. It dampens growth primarily by raising interest rates and reducing the supply of money. Higher interest rates cause consumers to reduce spending, especially through the use of credit cards.

Detailed explanation-5: -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.