Final answer:
An expansionary monetary policy is designed to lower interest rates and stimulate borrowing, which can boost economic growth by increasing aggregate demand. Conversely, a contractionary monetary policy aims to raise interest rates, curbing borrowing, and reducing aggregate demand to control inflation and prevent an overheated economy.
Step-by-step explanation:
A monetary policy that lowers interest rates and stimulates borrowing is known as an expansionary monetary policy or loose monetary policy. This approach is typically employed by central banks, such as the Federal Reserve in the United States, to increase aggregate demand and drive economic growth, especially during periods of economic slowdown or recession. By increasing the supply of money and loanable funds, interest rates are pushed down, which encourages additional borrowing for investment and consumption. This leads to an outward shift in the aggregate demand curve, which can result in a higher price level and, at least in the short run, a higher Gross Domestic Product (GDP).
Contrastingly, a contractionary monetary policy, also known as a tight monetary policy, involves raising interest rates and reducing the supply of money and credit. The central bank implements this policy to cool down an overheated economy, tackle inflation, and avoid the creation of economic bubbles. Higher interest rates make borrowing less attractive, which can depress investment and consumption, causing a leftward shift in aggregate demand, potentially leading to a lower price level and a decrease in real GDP in the short run.
Decisions about whether to pursue an expansionary or contractionary policy take into account macroeconomic goals such as controlling unemployment and inflation. The Fed's historical monetary policy practices over the last four decades showcase a strategic use of these policies to navigate different economic conditions.