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

Question

Quizplus · Accepted Answer

An inflationary gap occurs when aggregate demand exceeds the economy's potential output, leading to higher prices and inflation. A contractionary monetary policy involves decreasing the money supply, which leads to higher interest rates and reduced investment spending. This helps to decrease aggregate demand and bring it closer to the economy's potential output to close the inflationary gap. Therefore, the correct answer is C, which indicates that a contractionary monetary policy will decrease investment while increasing interest rates.

If the Economy Experiences an Inflationary Gap, a Contractionary Monetary