Tight monetary policy is used to raise interest rates and slow down the economy to achieve stability. The Federal Open Market Committee is responsible for implementing this policy through selling US Treasuries, increasing the discount rate, and increasing the reserve requirement. The goal is to create a stable economy.
A tight monetary policy is a tool the federal government uses to raise interest rates when they are too low. The same policy is implemented when the employment rate is very high. In short, it’s a way to slow down the economy and bring it to a more balanced or stable level.
In the US, the Federal Open Market Committee (FOMC) is part of the Federal Reserve and plays a central role in implementing monetary policy on behalf of the Federal Reserve. This is the committee that makes the decisions about what tools to use to control the economy and direct it in the direction it needs to go. It is the FOMC that meets, votes and decides to implement a restrictive monetary policy.
One way monetary policy occurs is when the FOMC sells US Treasuries. When people on the open market buy US Treasuries, it takes more money out of circulation, putting that money in the hands of the federal government.
Another way for the federal government to implement tight monetary policy is to increase the discount rate. The discount rate is the interest rate at which banks that are part of the Federal Reserve lend money to each other. When the discount rate increases, the amount of money that banks lend to each other decreases. When banks have less money to lend, it also takes money out of circulation for the general public – keeping it in the hands of the government.
A third way the Federal Reserve can implement this type of monetary policy is to increase the reserve requirement. Each bank in the Federal Reserve system is required to keep a certain level of money in the bank. The higher the reserve requirement, the more money the bank has to save, which means the less money the bank has to lend. When borrowing decreases, there is less money in circulation.
The ultimate goal of tight monetary policy and the other policies adopted by the Federal Reserve is to create a stable economy. If the Federal Reserve sees that employment rates are high and low, they may implement tight monetary policy. If the opposite is true, the Fed uses tools to pour money into the system and reach the general public in order to stabilize an economy that is experiencing high unemployment and a high interest rate environment.
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