Suppose the economy is experiencing an inflationary gap at the current level of GDP. Which of the following fiscal policy actions would be most appropriate given this gap?

Question

Quizplus · Accepted Answer

An inflationary gap is a situation where the economy is producing above its potential output and there is upward pressure on prices. To tackle this situation, we need contractionary fiscal policies that would reduce demand and prevent prices from rising. Option C, increasing taxes, is the most appropriate fiscal policy action in this case as it reduces disposable income of households and businesses, which would lead to a fall in spending and help reduce demand. Options A and B are monetary policy tools, not fiscal policy tools, and they are usually used to tackle demand-side inflationary pressures. Option D, a simultaneous increase in taxes and government spending, would have an ambiguous effect on the economy and might not be effective in controlling inflation.

Suppose the Economy Is Experiencing an Inflationary Gap at the Current