What is contractionary monetary policy?

• A. A government fiscal strategy of increasing public spending to stimulate short-term economic growth.
• B. A policy that pegs the currency by buying or selling foreign reserves to stabilize the exchange rate.
• C. A central bank policy that increases the money supply and lowers interest rates to boost aggregate demand and stimulate growth.
• D. A central bank policy that reduces the money supply and raises interest rates to decrease economic activity and curb inflation.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the role of monetary policy, which is conducted by a central bank to influence the economy by controlling the money supply and interest rates.
2. Step 2: Recognize that contractionary monetary policy is used to reduce inflation and slow down an overheating economy by decreasing aggregate demand.
3. Step 3: Identify the tools of contractionary monetary policy, such as increasing interest rates and reducing the money supply through selling government securities or raising reserve requirements.
4. Step 4: Note the effects of contractionary monetary policy: higher interest rates make borrowing more expensive, which reduces consumer spending and business investment, leading to slower economic growth.
5. Step 5: Summarize that contractionary monetary policy is a central bank strategy aimed at decreasing economic activity to control inflation, contrasting with expansionary policy which aims to stimulate growth.