If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase interest rates and increase the bond prices.
B) increase interest rates and decrease the bond prices.
C) decrease interest rates and increase the bond prices.
D) decrease interest rates and decrease the bond prices.

Question

Quizplus · Accepted Answer

When the economy experiences an inflationary gap, there is an excess demand for goods and services which leads to an increase in prices. To counter this, the central bank implements a contractionary monetary policy which involves selling government bonds in the open market. This decreases the money supply, which in turn increases interest rates and decreases the demand for goods and services. As a result of the increase in interest rates, bond prices will fall.

If the Economy Experiences an Inflationary Gap, a Contractionary Monetary