What is a contractionary Monetary Policy?

The contractionary monetary policy is the opposite of expansionary monetary policy. It is used to fight inflation which involves decreasing the money supply in order to increase the cost of borrowing which in turn decreases GDP and dampens inflation.
Once the Central Bank of the country (In India RBI) puts too much liquidity into the banking system, it risks triggering inflation. To contain the inflation the Central Bank places on brakes by implementing following contractionary or restrictive monetary policy. It’s also called as restrictive monetary policy because it restricts liquidity in the economy. The contractionary monetary policy decreases the money supply, increases interest rates, and decreases aggregate demand. It knocks down growth as measured by gross domestic product. It also increases the value of the currency, thereby increasing the exchange rate.
As a first step, the central bank focuses on decreasing the money supply by inflating key policy rates like repo rate, reverse repo rate, bank rate etc. or sell government securities through open market operation or by carrying out all the changes simultaneously. Further, the Central bank seeks to encourage decreased lending by banks and stipulates the higher cash reserve ratio, and or higher statutory liquidity ratio which is essentially the amount of capital a bank needs to hold onto when making loans. As a result, banks have less money available to lend. With less money to lend, they charge a higher interest rate.
The direct effects of increase in interest rates are that it increases borrowing costs. Increase in borrowing cost discourages corporates to borrow for business expansion. It dampens individual borrowers to go for home loan or auto loan or usage of credit cards at a prohibitive borrowing cost. On the other hand, the higher interest rate makes government bonds, bank deposits more attractive. It offers an opportunity to people added savings rather than spending more on consumption and investing in other riskier portfolios.
Bottom-line:
The contractionary monetary policy deters the expansionary phase of the business cycle. The main problem of contractionary monetary policy is the outcome, increase in the unemployment rate and a decrease in the growth rate of the GDP.