Explain how different monetary policies affect the money supply and the economy

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Monetary policies refer to actions that are taken by governments (or the duly appointed monetary regulatory committees in a country) to control the behavior of the economy. Monetary policies can be divided into two: contractionary and expansionary. When an expansionary monetary policy is implemented, the amount of money in circulation (in a country) is increased through lowering of interest rates. The ultimate effect of this is that business and consumer spending goes up (loans are easily available), unemployment rates drop and the economy grows. Contractionary measures are introduced through raising interest rates thereby liquidity (availability of money in the economy) is reduced. As a result, consumer spending reduces and so inflation is kept within sustainable levels.

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