Expansionary Monetary Policy vs Contractionary Monetary Policy
Expansionary Monetary Policy and Contractionary Monetary Policy are two Money & Monetary Policy concepts in AP Economics that students often mix up. In short: expansionary monetary policy is expansionary monetary policy increases the money supply to lower interest rates and stimulate aggregate demand. Meanwhile, contractionary monetary policy is contractionary monetary policy decreases the money supply to raise interest rates and reduce inflation. Here is how they compare side by side.
Expansionary monetary policy increases the money supply to lower interest rates and stimulate aggregate demand.
The central bank buys bonds, lowers the discount rate, or cuts the reserve requirement. Lower interest rates boost investment and interest-sensitive consumption, shifting aggregate demand right. It is used to fight recession and unemployment.
Contractionary monetary policy decreases the money supply to raise interest rates and reduce inflation.
The central bank sells bonds, raises the discount rate, or increases the reserve requirement. Higher interest rates reduce investment and consumption, shifting aggregate demand left. It is used to fight high inflation.