What is Tight Money?

Tight money is an economic situation in which there is less money available, which results in a corresponding reduction of available credit. This situation is also known as dear money and it is usually the result of tight money policy. Tight money policy is a monetary policy which is undertaken to address inflation, with the goal of slowing the rate of inflation so that it does not climb out of control. The reduction is available credit is viewed an acceptable tradeoff when compared with the consequences of long term runaway inflation.

Several factors can be combined to create tight money. One technique to reduce the amount of money available is to increase reserve requirements. With banks required to hold on to more money, there is less money available for lending, both between banks and from banks to consumers and institutions. This contributes to the development of reduced credit availability.

Toughening the standards for credit can also reduce the supply of credit by making less people eligible for it, or reducing the amount of loans for which people are eligible. This may be done in cases in which there are concerns that people are obtaining credit too easily and banks are being exposed to risks by lending to people who may be more candidates for credit. Inflation often causes a relaxation in lending policies, and tightening those policies up can help to curb inflation.

Selling government bonds is another component of tight money policy. In this case, the government essentially soaks up money by converting funds in the marketplace into bonds. The government sits on the money, while people who had those funds hold the bonds. The incentive for investors in this case is that they earn a steady interest on the bonds they buy and are eligible for repayment of the face value of the bond when it matures.

Enacting tight money policy requires a delicate hand. It is important to avoid swinging too far in the other direction and triggering deflation. Tightening up credit too much can also lead to an economic decline because there will naturally be less economic activity when there is less available credit. Regulators must walk a tightrope when it comes to shaping economic policy; they do not want to meddle excessively and destabilize the economy, but they also do not want to sit idly by while economic disasters unfold. Failure to act may be criticized later, even if there was no way to predict the outcome of economic events.