A restrictive monetary policy is a tool that the federal government uses to increase interest rates when they are too low. The same policy is implemented when the employment rate is too high. In short, it is a way to slow down the economy and bring it to a more balanced or stable level.
In the US, the Federal Open Market Committee (FOMC) is a part of the Federal Reserve and plays a pivotal role in implementing monetary policies on behalf of the Federal Reserve. This is the committee that makes decisions on which tools to use to control the economy and steer it in the direction in which it needs to go. It is the FOMC meets, votes and decides on putting a restrictive monetary policy in place.
One way that such a monetary policy occurs is when the FOMC sells U.S. Treasuries. When people in the open market buy U.S. Treasuries, it takes more money out of circulation, putting this money in the hands of the federal government.
Another way the federal government puts a restrictive monetary policy in place is increasing the discount rate. The discount rate is the interest rate at which banks that are a part of the Federal Reserve loan money to each other. When the discount rate increases, it decreases the amount of money that banks lend to each other. When banks have less money to lend then this also takes money out of circulation to the general public — keeping it in the hands of the government.
A third way that the Federal Reserve can deploy this type of monetary policy is to increase the reserve requirement. Each bank in the Federal Reserve system is required to maintain a certain level of money in the bank. The higher the reserve requirement is, the more money the bank has to save, which means the less money that the bank has to lend. When lending decreases then there is less money in circulation.
The ultimate goal of the restrictive monetary policy and the other policies the Federal Reserve employs is to create a stable economy. If the Federal Reserve sees that employment rates are high and rates are low, then they may deploy a restrictive monetary policy. If the opposite is true then the Fed uses tools to pour money into the system to get to the general public in order to stabilize an economy that is experiencing a high unemployment rate and high interest rate environment.
