Mumbai: A contractionary monetary policy leads to a decline in inflation and a decline in growth after a lag, found a study by the economists of the Reserve Bank of India (RBI).A contractionary policy is a monetary measure to reduce government spending or the rate of monetary expansion by a central bank. It is a macroeconomic tool used to combat rising inflation. The main contractionary policies employed by central banks include raising interest rates, increasing bank reserve requirements, and selling government securities.The study found that a contractionary monetary policy shock leads to a decline in aggregate consumption, a decline in inflation, a decline in investment, a decline in output, a decline in capital stock, and a decline in private formal employment. “Unemployment rises in both formal and informal labour markets. There is a decline in casual and self-employment, which leads to total informal employment falling,” said the paper titled Monetary Policy Transmission and Labour Markets in India. The study showed that formality in the labour market affects the impact of monetary policy shocks on inflation and other macroeconomic variables. “Monetary policy transmission under inflation targeting improves with more formality in the labour market,” said the study.
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