Figure: Monetary Policy and Demand Shocks Reference: Ref 16-2 (Figure: Monetary Policy and Demand Shocks) The real growth rate in this economy is 3 percent when a positive aggregate demand shock shifts the AD curve from AD1 to AD4. The correct monetary policy response is to
A) reduce money supply growth, so that the AD curve shifts back to AD1.
B) reduce money supply growth, so that the AD curve remains at AD4.
C) increase money supply growth, so that the AD curve shifts to AD3.
D) increase money supply growth, so that the AD curve shifts to AD5.

Question

Figure: Monetary Policy and Demand Shocks  Reference: Ref 16-2 (Figure: Monetary Policy and Demand Shocks) The real growth rate in this economy is 3 percent when a positive aggregate demand shock shifts the AD curve from AD1 to AD4. The correct monetary policy response is to
A) reduce money supply growth, so that the AD curve shifts back to AD1. 
B) reduce money supply growth, so that the AD curve remains at AD4. 
C) increase money supply growth, so that the AD curve shifts to AD3. 
D) increase money supply growth, so that the AD curve shifts to AD5.

Quizplus · Accepted Answer

The correct monetary policy response in this case would be to reduce money supply growth so that the AD curve shifts back to AD1. This would help to stabilize prices and prevent inflation. If the central bank were to increase money supply growth in response to the demand shock, it would likely lead to inflationary pressures and further destabilize the economy in the long run. Therefore, reducing money supply growth is the best choice.