If the Federal Reserve wants to close an inflationary gap, it will _____ the money supply and _____ the interest rate, thus _____ investment spending and GDP. The AD curve will shift to the _____.
A) increase; raise; increasing; right
B) increase; lower; lowering; left
C) decrease; raise; lowering; left
D) decrease; lower; lowering; right

Question

Quizplus · Accepted Answer

To close an inflationary gap, the Federal Reserve will decrease the money supply (to reduce spending) and raise interest rates (to discourage borrowing and spending). This will lead to a lowering of investment spending and GDP. The AD curve will shift to the left as aggregate demand decreases due to reduced spending. Option A is incorrect because increasing the money supply and raising the interest rate would not help to close an inflationary gap. Option B is incorrect because increasing the money supply and lowering the interest rate would only exacerbate inflation. Option D is incorrect because decreasing the money supply and lowering the interest rate would not be effective in closing an inflationary gap.

If the Federal Reserve Wants to Close an Inflationary Gap