Figure 16-2

-Assume that a contractionary monetary policy has shifted the aggregate demand curve in Figure 16-2 from D₀D₀ to D₁D₁.Fiscal authorities who wish to restore real GDP to the full-employment level will
A)run a budget surplus by increasing taxes or cutting government spending.
B)run a balanced budget to prevent the interest rate from rising and cutting off investment.
C)run a budget deficit by cutting taxes or increasing government spending.
D)ignore the change in monetary policy since it has no effect on fiscal policy.

Question

Figure 16-2
 
-Assume that a contractionary monetary policy has shifted the aggregate demand curve in Figure 16-2 from D₀D₀ to D₁D₁.Fiscal authorities who wish to restore real GDP to the full-employment level will
A)run a budget surplus by increasing taxes or cutting government spending. 
B)run a balanced budget to prevent the interest rate from rising and cutting off investment. 
C)run a budget deficit by cutting taxes or increasing government spending. 
D)ignore the change in monetary policy since it has no effect on fiscal policy.

Quizplus · Accepted Answer

Since the shift in the aggregate demand curve has decreased real GDP and increased unemployment, fiscal authorities should implement expansionary fiscal policy to counteract the contractionary monetary policy. This can be achieved by either cutting taxes or increasing government spending, which would increase aggregate demand and shift the curve to the right. Running a budget deficit would be a suitable option in this scenario, as it involves increasing government spending or reducing taxes, which would lead to an increase in aggregate demand.

Figure 16-2 -Assume That a Contractionary Monetary Policy Has Shifted the Aggregate