Monetary Policy and Economic Outcomes

Self-Check Questions

Why does contractionary monetary policy cause interest rates to rise?


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?


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.