Figure 10-6
-Refer to Figure 10-6. If the economy is experiencing an inflationary gap, the Fed would

Question

Figure 10-6 
-Refer to Figure 10-6. If the economy is experiencing an inflationary gap, the Fed would

Quizplus · Accepted Answer

To address an inflationary gap, the Fed needs to reduce aggregate demand in the economy. One way to do this is to decrease the money supply, which would increase interest rates and discourage borrowing and spending. Selling government bonds would achieve this goal, as it takes money out of circulation and decreases the money supply. Panel (b) in the graph shows the effects of this policy, with a decrease in real GDP and a decrease in the price level. Buying government bonds, as in option A or C, would increase the money supply and lead to further increases in aggregate demand, exacerbating the inflationary gap. Selling government bonds (option B) is the most appropriate policy response in this scenario. Option D is incorrect because selling government bonds would decrease, not increase, the money supply.

Figure 10-6 -Refer to Figure 10-6. If the Economy Is Experiencing an Is