Tight Monetary Policy

When central banks, like the Fed in the U.S., execute a tight monetary policy, it means they’re raising short-term interest rates via tweaking the federal funds rate. That makes borrowing more expensive for banks, which ripples outward, affecting both consumers and businesses.

The Fed tightens up monetary policy when it can afford to do so. That is, when the economy is feeling fly as hell. This can slow economic growth and spending. Which is no fun. Still, it’s necessary if the Fed wants to have tools at the ready when the next recession hits. Most economists, businesses, and consumers have come around to the idea that we can assume economic highs and lows. In the Keynesian style, the U.S. and most other modern-day central banks intervene when a recession hits.

One of the things central can do when, um...poo hits the fan...is to lower interest rates. Basically, putting interbank loans on sale, enticing investing and buying, and therefore spending. This is called quantitative easing, i.e. making borrowing cheaper.

But if interest rates are already low when a recession hits (i.e. they're already “on sale”), then it’s not really a tool at the central bank’s disposal. Thus, a tight monetary policy during economic peaks is essential for refueling central banks’ tools, preparing for the next economic downslide.