Restrictive monetary policy

The restrictive monetary policy or contractive monetary policy of a central bank comprises all monetary policy measures that lead to a reduction in the amount of money in circulation . It leads to increases in interest rates, a decrease in production and investment and is intended to slow down the rise in the price level, i.e. reduce inflationary tendencies (price stability). Restrictive monetary policy is mainly used in times of economic overheating. It can be understood as the counterpart to the expansionary monetary policy .

overview

A contractionary monetary policy is causing the domestic interest rate to rise. This makes domestic securities more attractive, and the demand for the local currency increases and it appreciates . Both the higher interest rate and the appreciation of the currency (consequence: more imports, fewer exports) cause a decline in overall economic demand and production. With the decline in demand and production, so does the demand for money, which means that interest rates fall again. The aim is to reduce inflationary tendencies.

activities

The classic instrument of the central bank to influence the money supply is the discount policy (ECB: main refinancing instrument ). This means, on the one hand, the possibility of regulating the level of the key interest rate at which the commercial banks can take credit from the central bank in order to compensate for any lack of liquidity from their own lending, on the other hand, the central bank can (more) limit the monetary base (central bank money ) to the credit institutions in terms of quantity. so that there tends to be less lending to non-banks .

In principle, the central bank can also intervene by means of minimum reserve requirements : With regard to the limitation of money creation , the commercial banks - e. B. in the member states of EMU - obliged to reserve a certain percentage (currently 1%) of their liquid funds (depending on the [short-term] deposit holdings [sight deposits] they manage). The increase in the minimum capital requirements for credit risks has a much more restrictive effect .

These instruments are intended to regulate bank reserves, money supply and interest rates in order to achieve set goals (e.g. price stability, reduction in net borrowing , reduction in the current account deficit, etc.).

Effects

Graphic analysis of the restrictive monetary policy

Interaction of the AS-AD and IS-LM models

In summary, the restrictive monetary policy can be presented as follows:

The bank reserves are reduced (mainly through price or volume allocations).
The reduction in bank reserves leads to multiple shortages in book money and the money supply.
The reduced money supply leads along the money demand function to an increase in interest rates.
The interest rate hike and the shortage of money supply curb investment, consumption and net exports .
The declines in interest-sensitive items reduce overall demand due to the well-known multiplication effect.

The lower level of total demand lowers the level of production and prices - disinflation.

Abstract: bank reserves ↓, available money ↓, interest rate ↑, investment ↓, consumption ↓, net exports ↓, aggregate demand ↓, real GDP ↓, production ↓, inflation ↓, unemployment ↑

Monetary policy can have different effects in the short term and in the long term. In the short term, a change in the money supply affects the AD curve , with a relatively flat AS curve , for the most part on production and only to a small extent on the price level. In the long term, on the other hand, when the AS curve adopts an almost vertical course, shifts in the money supply mainly lead to changes in the price level and hardly any changes in production output. In the extreme case, when changes in the money supply only affect nominal variables without affecting real variables, it can be said that every change in money supply always has the same effect (short and long-term). The targeted price stability is directly related to the inflation rate. Furthermore, inflation is directly related to unemployment, with the Phillips curve being an important analytical tool. The curve illustrates the relationship between inflation and unemployment. In the short term, this means that lowering one leads to increasing the other.

Monetary Policy in an Open Economy

The monetary control instruments described above are very effective instruments. However, it cannot completely control the money supply. The central bank faces fundamental problems that arise from the two-tier financial system (central bank and commercial banks), partial reserve management and globalization . The first problem is that the central bank cannot control the amount of money that households hold as deposits in the banking system.

To better illustrate this problem, let us assume that people are losing confidence in the banking system and decide to liquidate a large part of their deposits and instead keep it in cash. As a result, less money can be drawn in the banking system, so that the money supply declines without the central bank intervening. The second problem is that the central bank has no control over how much credit the banks make. So that this problem can also be well described, it can be assumed that one day the banks will become more cautious due to a worsened assessment of the economic situation and thus grant fewer loans. This passive behavior automatically increases the reserves of the commercial banks, and the money in circulation also decreases here. In the partial reserve system, the money supply depends in part on the behavior of depositors and commercial banks. The third problem arises from the increasing globalization of trade and finance (open economy). The flexible exchange rates and net exports are influenced by any change in monetary policy, which further complicates the monetary mechanism for the central bank.

In order to better explain the problem, let's assume that the central bank raised the interest rate. As a result, domestic securities are becoming more attractive and foreign investors want to invest in these securities. This increases the value of the domestic currency, which makes domestic goods more expensive than foreign ones. This in turn has the consequence that the demand for domestic products decreases, i.e. H. it decreases production. As a result, a change in interest rates has an impact on production both directly via the central bank and indirectly via exchange rates. Consequently, the central bank makes an open economy both because of the inexactly determinable connection between money supply and net exports as well as because of the additional political and economic questions arising from the effects of domestic politics on foreign economies, on the composition of GDP and on the debt burden of third parties World devoted to creating. However, the behavior of the depositors or commercial banks can be determined in advance by constantly checking the development of deposits and changing reserves. This means that countermeasures can be taken quickly to keep the money supply close to the planned volume.

literature

Paul A. Samuelson, William D. Nordhaus: Economics , Dt. Translation 15th ed., Redline Wirtschaft at Ueberreuter Verlag Frankfurt / Vienna 1998, ISBN 3-8323-0414-2
Oliver Blanchard, Gerhard Illing: Macroeconomics , 4th edition. Pearson Studium Verlag Munich 2006, ISBN 3-8273-7209-7
Gustav Dieckheuer: Macroeconomics Theory and Politics , 5th edition, Springer Verlag Berlin 2003, ISBN 3-5400-0564-1

Individual evidence

^ Gabler Wirtschaftslexikon, keyword: monetary policy , Springer Gabler Verlag
↑ Olivier Blanchard, Gerhard Illing, Makroökonomie , Pearson Deutschland GmbH, 2009, ISBN 9783827373632 , p. 603
^ Heinrich Rittershausen: Economy. Frankfurt 1958. p. 164:
"If the banks give too much credit to the other commercial enterprises, so that there is a risk of expansionary overvoltage (" overheating ") (extreme case: inflation), the central bank (Bundesbank) can" brake "by the minimum reserves increased. The credit institutions then have to hold large amounts of cash at the central institution free of interest and are forced to limit their credit ( credit restriction ). [...] In the event of a depression, the mandatory reserves can be reduced. "
↑ Deutsche Bundesbank, Sabine Lautenschläger (Basler Committee / BIS ): Basel III and the SME sector: "Excessive capital requirements can lead to an uncontrolled reduction in bank assets and result in a credit crunch ." (Speech of March 29, 2012: Conclusion 2.) Retrieved February 18, 2013.

[1] Gabler Wirtschaftslexikon, keyword: monetary policy , Springer Gabler Verlag

[2] Olivier Blanchard, Gerhard Illing, Makroökonomie , Pearson Deutschland GmbH, 2009, ISBN 9783827373632 , p. 603

[3] Heinrich Rittershausen: Economy. Frankfurt 1958. p. 164:
"If the banks give too much credit to the other commercial enterprises, so that there is a risk of expansionary overvoltage (" overheating ") (extreme case: inflation), the central bank (Bundesbank) can" brake "by the minimum reserves increased. The credit institutions then have to hold large amounts of cash at the central institution free of interest and are forced to limit their credit ( credit restriction ). [...] In the event of a depression, the mandatory reserves can be reduced. "

[4] Deutsche Bundesbank, Sabine Lautenschläger (Basler Committee / BIS ): Basel III and the SME sector: "Excessive capital requirements can lead to an uncontrolled reduction in bank assets and result in a credit crunch ." (Speech of March 29, 2012: Conclusion 2.) Retrieved February 18, 2013.