Refer to the graph above. Assume that the economy is initially in equilibrium at the intersection of AD₁ and AS₁. Suppose that there is economic growth which shifts AS₁ to AS₂. If the application of a monetary rule is designed to shift AD₁ to AD₃, but because of pessimistic business expectations AD₁ only shifts to AD₂, then mainstream economists would suggest that the actions to be taken to avoid deflation would be to implement a(n): A) Expansionary fiscal policy and a tight money policy B) Contractionary fiscal policy and a tight money policy C) Expansionary fiscal policy and an easy money policy D) Contractionary fiscal policy and an easy money policy

Question

Quizplus · Accepted Answer

Since there is pessimistic business expectations, which could lead to a decrease in aggregate demand, this presents a risk of deflation. Therefore, an expansionary fiscal policy (such as an increase in government spending or a decrease in taxes) and an easy money policy (such as a decrease in interest rates) can help stimulate aggregate demand and avoid deflation.

Refer to the Graph Above