Tight Money Policy
This policy is exercised in times of inflation.
Components:
1. Selling securities to banks and the public.
This decreases the supply of money. The public is giving money to the Federal Reserve. In exchange, the Fed is giving the public/banks bonds, which isn't money. Hence, there is less money circulating in the economy.
Because banks now have less reserves, they cannot loan as much money to the public.
2. Increase the Federal Funds Rate
By increasing the Federal Funds rate, it costs more interest for banks to borrow from other banks. Thus, banks have less excess reserves and lend less to the public.
3. Increasing the Discount Rate
Commercial banks loaning from the Federal Reserve now have less excess reserves. Therefore, they cannot loan as much money to the public.
4. Increase the Reserve Ratio
By increasing the reserve ratio, banks now have less excess reserves. Therefore, money supply has been decreased, and the banks cannot loan as much money to the public.
Effects
of Changing Money Supply on Aggregate Demand
1. interest rates rise
2. investment falls
3. aggregate demand falls
The steeper the Dm curve, the larger the effect of any given change in the money supply on the equilibrium rate of interest. Furthermore, any given change in the interest rate will have a larger impact on investment - and hence a greater impact on aggregate demand and GDP.
As a side note, an
tight money policy decreases net exports because of higher interest rates
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