If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase real GDP and increase the price level.
B) increase real GDP and decrease the price level.
C) decrease real GDP and increase the price level.
D) decrease real GDP and decrease the price level.

Question

Quizplus · Accepted Answer

An inflationary gap occurs when actual output is above the full-employment level of output, causing prices to rise due to excess demand. To close this gap, a contractionary monetary policy is implemented, which reduces the money supply and increases interest rates. This discourages borrowing and spending, which in turn reduces aggregate demand and causes a decrease in real GDP. Additionally, the reduction in spending leads to a decrease in prices, further closing the inflationary gap. Therefore, the correct choice is D as it describes a decrease in real GDP and a decrease in the price level.

If the Economy Experiences an Inflationary Gap, a Contractionary Monetary