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Monetary policy instruments

Expansionary policy occurs when a monetary authority uses its instruments to stimulate the economy. An expansionary policy decreases short-term interest rates, affecting broader financial conditions to encourage spending on goods and services, in turn leading to increased employment. By affecting the exchange rate, it may also stimulate net export. Contractionary policy works in the opposite direction: Increasing interest rates will depress borrowing and spending by consumers and businesses, dampening inflationary pressure in the economy together with employment.