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    Contractionary monetary policy

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    Which statement is true when the fed is implementing a contractionary monetary policy?

    1. fed decreases money supply in economy by increasing federal funds rate; or
    2. fed increases federal funds rate by decreasing money supply in economy

    if 1, fully and precisely explain how federal funds rate is set by fed
    if 2, fully, precisely explain how money supply is decreased by fed

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    Source: Use has been made of materials at sites:
    http://internationalecon.com/v1.0/Finance/ch40/F40-5.html
    http://www.frbsf.org/econrsrch/wklyltr/wklyltr99/el99-01.html

    Which statement is true when the fed is implementing a contractionary monetary policy?

    1. fed decreases money supply in economy by increasing federal funds rate; or

    2. fed increases federal funds rate by decreasing money supply in economy

    if 1, fully and precisely explain how federal funds rate is set by fed
    if 2, fully, precisely explain how money supply is decreased by fed

    Answer: 1. fed decreases money supply in economy by increasing federal funds rate
    Tight or contractionary monetary policy makes credit expensive (higher interest rate) and in short supply in an effort to slow the economy. Contractionary policy can be implemented by reducing the size of the monetary base. This directly reduces the total amount of money circulating in the economy.
    The Federal Funds rate is the interest rate banks charge each other for short-term (usually overnight) loans. The Fed does not actually set the federal funds rate, but it does employ open market ...

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