Contractionary policy refers to a type of economic policy aimed at reducing the money supply and controlling inflation. This approach is typically employed by central banks or governments to slow down an overheating economy, curb excessive inflation, or stabilize the currency. There are two main types of contractionary policies:
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Monetary Policy: This involves actions taken by a central bank to increase interest rates or sell government bonds to reduce the amount of money available in the economy. Higher interest rates tend to discourage borrowing and spending by consumers and businesses, which can help to reduce inflationary pressures.
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Fiscal Policy: This involves reducing government spending or increasing taxes. By lowering spending or increasing taxes, disposable income for consumers decreases, which can also lead to a slowdown in economic activity and help keep inflation in check.
In summary, contractionary policy is designed to tighten economic activity in order to restore balance and prevent runaway inflation, often implemented when the economy is growing too quickly or is at risk of overheating.