If inflation increases, the central bank acts to raise interest rates in order to
A)increase the money supply.
B)reduce real GDP.
C)increase real GDP.
D)increase potential GDP.
E)reduce potential GDP.

Question

Quizplus · Accepted Answer

When inflation increases, raising interest rates is a contractionary monetary policy tool used by central banks to slow down economic growth, and eventually reduce real GDP. By increasing the cost of borrowing, people tend to spend less, and investment in projects tend to be less profitable, leading to a decrease in economic activity, and the reduction of prices in the long run.

If Inflation Increases, the Central Bank Acts to Raise Interest