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Exhibit: The Money Supply and Aggregate Demand
-(Exhibit: The Money Supply and Aggregate Demand) If the economy is experiencing an inflationary gap, the Fed would

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Use the following to answer questions .
Exhibit: The Money Supply and Aggregate Demand 
-(Exhibit: The Money Supply and Aggregate Demand) If the economy is experiencing an inflationary gap, the Fed would

Quizplus · Accepted Answer

If the economy is experiencing an inflationary gap, it means that aggregate demand is greater than the potential output of the economy, which leads to inflation. To counteract this, the Fed would sell government bonds, which decreases the money supply and increases interest rates. The higher interest rates decrease investment and consumption spending, which in turn decreases aggregate demand and reduces inflationary pressures. This is represented in Panel (b) of the exhibit.

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