Essay on Macroeconomics: Contractionary Monetary Policy

Submitted By chimechanga
Words: 648
Pages: 3


Macroeconomics came to be a branch of economics during the Great Depression. When the Great Depression hit, it left a quarter of the United States workforce without any jobs. It also affected the political stability of many countries since our economy was affected. Economist realized after the immense impact of the recession that they needed to understand and learn how to prevent these catastrophes. So what they came up with were some policies and theories such as Monetary Policy, Fiscal Policy and Keynesian economics. Keynesian economics, according to British economist John Maynard Keynes, states that a depressed economy is the result of inadequate spending. He argued that government intervention could help a depressed economy through monetary and fiscal policy.
A simple example to understand macroeconomics more is what macroeconomists call the paradox of thrift. The paradox of thrift is a concept when families and businesses worry about possible future economic hardships and prepare by reducing their spending. With their reduction in spending though, they end up hurting themselves by hurting the economy as a whole. What families believe to be helpful actually hurts them in the long run. Monetary policy is when the Federal Reserve uses changes in the quantity of money to alter interest rates, which affects the level of overall spending particularly in the areas of employment, production, and prices. The Federal Reserve is the central bank for the United States; basically it’s a bank for banks. This central bank contains several branches around the United States to hold deposits for banks. This allows banks in need of assistance to pull out money when they are struggling. Another measure the Federal Reserve uses to ensure safety is requiring banks to have a certain percent of their deposits at a Federal Reserve Bank. The percentage they require banks to have is called the reserve requirement and if the bank cannot meet the requirement, then they can borrow from the Federal Reserve to help them. The two types of Monetary Policy that can be used are Expansionary Monetary Policy and Contractionary Monetary Policy. The Federal Reserve would use the Expansionary Monetary policy when policymakers feel like employment is too low and interest rates are too high. They could help the economy by lowering the reserve requirement or by lowering the discount rate. Either of these decisions could increase the supply of money. For example by lowering the reserve requirement, banks will have more of their deposits available for lending. That allows the money that is lent out to be cheaper,