Contractionary macro-economic policy

Contractionary policy is implemented when policy makers use monetary or fiscal policy to constrain aggregate spending in an economy. This is often used in response to excessive growth above an economy’s trend rate which may create unwanted inflationary pressure.

This would, typically, mean raising interest rates or reducing the money supply – in the case of monetary contraction – or raising taxes or reducing real government spending – in the case of a fiscal contraction.

This can be illustrated diagrammatically, using the AD-AS model.

contractionary policy