If a country`s GDP grows too fast and inflation exceeds a desirable rate of 2%, central banks will implement a monetary policy of contraction. The inflation-targeting and monetary policy approach was developed in New Zealand. It has been used in Australia, Brazil, Canada, Chile, Colombia, Czech Republic, Hungary, New Zealand, Norway, Iceland, India, Philippines, Poland, Sweden, South Africa, Turkey and the United Kingdom. To cool this overheated economic engine, a country`s central bank will implement a contractionary monetary policy to slow rapid growth and price increases. Expansionary monetary policy stimulates the economy. The central bank uses its tools to increase the money supply. It often does this by lowering interest rates. It can also take advantage of expansive open market operations called quantitative easing. In the context of monetary targeting, nominal income targeting (also known as nominal GDP targeting or NGDP), originally proposed by James Meade (1978) and James Tobin (1980), was endorsed by Scott Sumner and reinforced by the market monetarist school of thought. [39] The result of the increase in the price of credit, goods and money itself: a reduction in consumer and business spending, a decrease in demand. When demand falls, prices fall – and inflation is brought under control.
Other heterodox monetary policy proposals include the idea of helicopter money, in which central banks would create money without assets as a counterpart in their balance sheets. The money created could be distributed directly to the population in the form of a citizen dividend. The benefits of such a currency shock include lower household risk aversion and rising demand, which drives both inflation and the output gap. This option has been increasingly discussed since March 2016, after ECB President Mario Draghi described the concept as “very interesting”. [31] The idea was also promoted by former central bankers Stanley Fischer and Philipp Hildebrand in an article published by BlackRock[32] and in France by economists Philippe Martin and Xavier Ragot of the French Council for Economic Analysis, a think tank affiliated with the Prime Minister`s Office. [33] There is still debate about whether monetary policy can (or should) smooth business cycles. A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run because a significant number of prices in the economy are set in the short run and firms will produce as many goods and services as demand (in the long run, however, money is neutral, as in the neoclassical model). However, some economists in the new classical school argue that central banks cannot influence business cycles. [55] Monetary policy is a change in the money supply, that is, “printing” more money or reducing the money supply by changing interest rates or eliminating excess reserves. This contrasts with fiscal policy, which relies on taxes, public spending and public debt[4] as methods for a government to deal with economic phenomena such as recessions. The Fed maintains a portfolio of government bonds and treasuries that are sold to commercial banks in exchange for securities. This strategy forces banks to charge higher interest rates, which leads to a contraction in the money supply.
Alternatively, the central bank can increase the discount rate. When commercial banks face cash flow problems, they can exchange their short-term bills of exchange and currencies at the central bank. This means borrowing at a higher discount rate from the central bank, which actually exercises a restrictive monetary policy to limit the money supply. An expansionary (or loose) monetary policy raises the supply of money and credit beyond what it would otherwise have been and lowers interest rates, stimulating aggregate demand and thus counteracting the recession. A monetary policy of contraction, also known as restrictive monetary policy, reduces the amount of money and credit below what it would otherwise have been and raises interest rates to keep inflation low. .