Monetary Policy and Economic Outcomes

Self-Check Questions

Why does contractionary monetary policy cause interest rates to rise?

Hint:

Contractionary policy reduces the amount of loanable funds in the economy. As with all goods, greater scarcity leads a greater price, so the interest rate, or the price of borrowing money, rises.

Why does expansionary monetary policy causes interest rates to drop?

Hint:

An increase in the amount of available loanable funds means that there are more people who want to lend. They, therefore, bid the price of borrowing (the interest rate) down.