Whilst Linking to Inflation Explain What Monetary Policy Would Be Adapted Duringa Boom Period.

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Contractionary monetary policies or tighten monetary policies includes selling government bonds (open market operation), raise the reserve requirement and interest rate would pulls money out of the economy. The main purpose of a contractionary monetary policy is to slow down the inflation that accompanies with a booming economy. Open market operation can be both expansionary and contractionary monetary policy. The increase in supply of bonds reduces the price for bonds; thereby attract foreign investors to buy up the bonds. This will take money out of the circulation. Demand for domestic currency will increase, and lead to an appreciation in value, causing an increase in exchange rate. A higher exchange rate will lead to a fall in the cost of imported goods and services but also a fall in demand for exports, this cools off the markets and brings down overall demand, price goes down. Moreover, a rise in reserve requirement means banks need to devote more reserves to back up deposits; banks make fewer loans with higher interest rates, which discourage people from lending money. Low purchasing power will directly affect the aggregate production, with fewer resources are used, unemployment rate rise, there is less pressure on price, and therefore reducing the inflation rate as the supply is greater than demand. An increase in interest rate will have multiple effects. Firstly it stops firms from expanding, when the purchasing power has reduced, firms sell less and make less profit. Firms will cut the production and size of their workforces to reduce their costs; unemployment rate rise and people are less likely to spend. Secondly, the saving ratio will increase; less money is in the circulation. This helps to reduce the effect of inflation, but possibly lead to deflation. However, higher short-term interest rates, resulting from contractionary monetary policy, can
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