Figure 16-2

-Suppose that Figure 16-2 shows the effects of reducing the budget deficit by raising taxes.If authorities do not want real GDP to fall, monetary policy must
A)become sufficiently more expansionary to restore the aggregate demand curve to D? D?
B)contract aggregate demand to be consistent with deficit-reducing fiscal policy.
C)not lower interest rates and thwart the goal of a balanced budget.
D)become more contractionary to lower the interest rate and spur investment.

Question

Figure 16-2
 
-Suppose that Figure 16-2 shows the effects of reducing the budget deficit by raising taxes.If authorities do not want real GDP to fall, monetary policy must
A)become sufficiently more expansionary to restore the aggregate demand curve to D? D? 
B)contract aggregate demand to be consistent with deficit-reducing fiscal policy. 
C)not lower interest rates and thwart the goal of a balanced budget. 
D)become more contractionary to lower the interest rate and spur investment.

Quizplus · Accepted Answer

If authorities do not want real GDP to fall after the implementation of fiscal policy, they need to offset the contractionary effect of the policy by adopting expansionary monetary policy. This will shift the AD curve back to its original position (D₀D₀) and maintain real GDP at its initial level. Therefore, option A is the best choice as it suggests that monetary policy must become sufficiently more expansionary to restore the AD curve to its original position.

Figure 16-2 -Suppose That Figure 16-2 Shows the Effects of Reducing the Effects