Use the following to answer questions: -(Figure: Fiscal Policy with a Fixed Money Supply) Refer to Figure: Fiscal Policy with a Fixed Money Supply. Assume that this economy is at E₂. Now government deficit spending is decreased, but the Federal Reserve expands the money supply. According to this model: A) real GDP will decrease just as much as it would if the Federal Reserve had not expanded the money supply. B) real GDP will decrease, but not as much as it would if the Federal Reserve had failed to expand the money supply. C) real GDP will expand, but not as much as it would if the Federal Reserve had not expanded the money supply. D) interest rates will increase.

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When the government decreases deficit spending, it typically leads to a decrease in aggregate demand, which can reduce real GDP. However, if the Federal Reserve expands the money supply at the same time, it can offset some of the negative impact on real GDP by making more funds available for investment and consumption, thus lowering interest rates and stimulating economic activity. This means real GDP will still decrease, but the expansion of the money supply by the Federal Reserve will mitigate the extent of the decrease.

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