Contractionary fiscal policy would be most effective in decreasing inflation when

Question

Quizplus · Accepted Answer

If investment spending is insensitive to interest rates, then contractionary fiscal policy (such as decreasing government spending or increasing taxes) will not reduce aggregate demand and may even worsen the situation by decreasing output and increasing unemployment. Therefore, it is not an effective tool to combat inflation. If investment spending is sensitive to interest rates, then contractionary fiscal policy can be more effective in reducing aggregate demand and curbing inflation.

Contractionary Fiscal Policy Would Be Most Effective in Decreasing Inflation