adminContractionary Policy
Definition: A contractionary policy is a kind of policy which lays emphasis on reduction in the level of money supply for a lesser spending and investment thereafter so as to slow down an economy.
Description: A nation’s central bank uses monetary policy tools such as CRR, SLR, repo, reverse repo, interest rates etc to control the money supply flows into the economy. Such measures are used at high growth periods of the business cycle or in times of higher than anticipated inflation. Discouraging spending by way of increased interest rates and reduced money supply helps control rising inflation. It may also lead to increased unemployment at the same time.
The idea here is to make the opportunity cost of holding money high so that people want to hold and spend less of it. The effectiveness of this policy may vary depending upon the specific spending and investment patterns in any economy.
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Deflation: When the overall price level decreases so that inflation rate becomes negative, it is called deflation. It is the opposite of the often-encountered inflation.
Description: A reduction in money supply or credit availability is the reason for deflation in most cases.
Reduced investment spending by government or individuals may also lead to this situation. Deflation leads to a problem of increased unemployment due to slack in demand.
Central banks aim to keep the overall price level stable by avoiding situations of severe deflation/inflation. They may infuse a higher money supply into the economy to counter- balance the deflationary impact. In most cases, a depression occurs when the supply of goods is more than that of money.
Deflation is different from disinflation as the latter implies decrease in the level of inflation whereas on the other hand deflation implies negative inflation.
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Monetary Policy
Definition: Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
Description: Monetary policy is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth. The RBZ implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments.
Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy.
Monetary policy can be expansionary and contractionary in nature.
Increasing money supply and reducing interest rates indicate an expansionary policy.
The reverse of this is a contractionary monetary policy.
For instance, liquidity is important for an economy to spur growth.
To maintain liquidity, the RBZ is dependent on the monetary policy. By purchasing bonds through open market operations, the RBZ introduces money in the system and reduces the interest rate.
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Purchasing Power Parity
Definition: The theory aims to determine the adjustments needed to be made in the exchange rates of two currencies to make them at par with the purchasing power of each other. In other words, the expenditure on a similar commodity must be same in both currencies when accounted for exchange rate. The purchasing power of each currency is determined in the process.
Description: Purchasing power parity is used worldwide to compare the income levels in different countries. PPP thus makes it easy to understand and interpret the data of each country.
Example: Let’s say that a pair of shoes costs R1,400 in South Africa. Then it should cost $100 in Zimbabwe when the exchange rate is 14 between the dollar and the Rand.
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Recession
Definition: Recession is a slowdown or a massive contraction in economic activities. A significant fall in spending generally leads to a recession.
Description: Such a slowdown in economic activities may last for some quarters thereby completely hampering the growth of an economy. In such a situation, economic indicators such as GDP, corporate profits, employments, etc., fall. This creates a mess in the entire economy. To tackle the menace, economies generally react by loosening their monetary policies by infusing more money into the system, i.e., by increasing the money supply.
This is done by reducing the interest rates. Increased spending by the government and decreased taxation are also considered good answers for this problem.
The recession which hit the globe in 2008 is the most recent example of a recession.
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