Expansionary Monetary Policy vs Contractionary Monetary Policy: Meaning, Differences & Easy Explanation

The Reserve Bank of India (RBI) uses monetary policy to control money supply, inflation, borrowing costs, and overall economic activity. Two major types of monetary policy are:

• Expansionary Monetary Policy
• Contractionary Monetary Policy

What Is Expansionary Monetary Policy?

Expansionary Monetary Policy is used when the economy is slowing down, unemployment is rising, or demand is weak.

Objective: To increase money supply, boost demand, and encourage economic growth.

How Expansionary Monetary Policy Works

The central bank makes borrowing cheaper and increases liquidity by:

• Lowering Repo Rate
• Lowering Reverse Repo Rate
• Reducing CRR (Cash Reserve Ratio)
• Buying government securities (OMO purchases)
• Providing more loans to banks

Effects of Expansionary Policy

• Lower interest rates
• Cheaper loans
• Higher spending by consumers
• Higher business investment
• Employment rises
• Economic growth increases

Example

During COVID-19, RBI reduced repo rates to promote borrowing and support economic recovery. This is expansionary policy.

What Is Contractionary Monetary Policy?

Contractionary Monetary Policy is used when inflation is high or the economy is overheating.

Objective: To reduce money supply, control inflation, and stabilize prices.

How Contractionary Monetary Policy Works

The central bank reduces liquidity by:

• Increasing Repo Rate
• Increasing Reverse Repo Rate
• Raising CRR
• Selling government securities (OMO sales)
• Making loans more costly

Effects of Contractionary Policy

• Higher interest rates
• Costlier loans
• Reduced consumer spending
• Lower business investment
• Slower economic growth
• Inflation decreases

Example

When inflation crossed 7%, RBI increased repo rate repeatedly to reduce money supply.
This is contractionary policy.

Expansionary vs Contractionary Monetary Policy: Key Differences

Easy Trick to Remember