Assume that the economy is at full employment and is experiencing rapid inflatio

Question

Assume that the economy is at full employment and is experiencing rapid inflation. Which of the following combinations of monetary and fiscal policies would reduce inflation most, assuming the dollar values for both policy changes are the same amount?

Monetary Policy Buy government securities; Fiscal Policy Increase the federal budget deficit

Monetary Policy Buy government securities; Fiscal Policy Decrease the federal budget deficit

Monetary Policy Sell government securities; Fiscal Policy Increase the federal budget deficit

Monetary Policy Sell government securities; Fiscal Policy Decrease the federal budget deficit

Monetary Policy Buy government securities; Fiscal Policy Increase the federal budget deficit

Monetary Policy Buy government securities; Fiscal Policy Decrease the federal budget deficit

Monetary Policy Sell government securities; Fiscal Policy Increase the federal budget deficit

Monetary Policy Sell government securities; Fiscal Policy Decrease the federal budget deficit

Explanation / Answer

D. Monetary Policy Sell government securities; Fiscal Policy Decrease the federal budget deficit

By selling the government securities , the Government will reduce the money supply in the economy and hence increase the interest rates .

Controlling aggregate demand is important if inflation is to be controlled. Government must ‘tighten fiscal policy’ by reducing its own spending on public and merit goods or welfare payments and hence decrease the fedral budget deficit.

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