What does contractionary monetary policy typically involve?

Contractionary monetary policy is designed to reduce inflation and stabilize an overheating economy by decreasing the overall money supply. This is typically achieved through two main mechanisms: lowering the money supply and increasing interest rates.

By lowering the money supply, the central bank can make borrowing more expensive, which tends to cool down consumer spending and business investments. When the money supply is reduced, financial institutions have less capital to lend, leading to an increase in interest rates. Higher interest rates further discourage borrowing and spending, thereby slowing down economic activity and helping to control inflation.

This dual approach of lowering the money supply while increasing interest rates illustrates that both actions work together to tighten monetary conditions and achieve the goals of contractionary policy. Therefore, the correct answer reflects the comprehensive nature of contractionary monetary policy, as it includes both lowering the money supply and increasing interest rates as key components of its strategy.