Tight, or contractionary, monetary policy seeks to slow economic growth to head off inflation. The Federal Reserve might increase reserve requirements, the amount of money banks must hold to cover deposits, and increase the discount rate, the rate charged to banks which borrow money to cover reserve requirements.

Fiscal policy has a stabilizing effect on an economy if the budget balance—the difference between expenditure and revenue—increases when output rises and decreases when it falls. Either way, higher deficit (or a lower surplus) effectively cushions the blow on output.

Monetary and fiscal policy tools are used in concert to help keep economic growth stable with low inflation, low unemployment, and stable prices.

In a tightening policy environment, the Fed can also sell Treasuries on the open market in order to absorb some extra capital during a tightened monetary policy environment. Tightening policy occurs when central banks raise the federal funds rate, and easing occurs when central banks lower the federal funds rate.

In order to pursue a tight-money policy, the Federal Reserve can “decrease the amount of money in the economy”. This is primarily done by selling securities and bonds.

Why would the Federal reserve enact an easy money policy? The Federal Reserve enacts a tight money policy when the economy is having rapid expansion which can cause high inflation. By doing this it uses monetary policies that reduce the money supply.

Why would the Federal Reserve enact an easy money or a tight money policy? If the economy is in a contraction, the Fed will want to expand it with an easy money policy. If the economy is rapidly expanding, that can cause high inflation, and so the Fed with want to enact a tight money policy.

The primary tool the Federal Reserve uses to conduct monetary policy is the federal funds rate—the rate that banks pay for overnight borrowing in the federal funds market.

To increase money supply, Fed can lower discount rate, which encourages banks to borrow more reserves from Fed. Banks can then make more loans, which increases the money supply. To decrease money supply, Fed can raise discount rate.

Key Concepts and Summary 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.

A monetary policy that lowers interest rates and stimulates borrowing is known as an expansionary monetary policy or loose monetary policy. Conversely, a monetary policy that raises interest rates and reduces borrowing in the economy is a contractionary monetary policy or tight monetary policy.

Easy money is when the Fed allows cash to build up within the banking system—as this lowers interest rates and makes it easier for banks and lenders to loan money. The Fed looks to create easy money when it wants to lower unemployment and boost economic growth, but a major side effect of doing so is inflation.

In addition, the decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the aggregate demand curve to the left. This reduction in money supply reduces price levels and real output, as there is less capital available in the economic system.