Final answer:
To enact contractionary monetary policy, the Federal Reserve may decrease the money supply by increasing the reserve requirement ratio, leading to higher interest rates and reduced spending.
Step-by-step explanation:
If the Federal Reserve wants to enact contractionary monetary policy, they may choose actions that decrease the money supply. Among the options provided, the correct one is: decrease the money supply by increasing the reserve requirement ratio.
Increasing the reserve requirement ratio means banks must hold more funds in reserve and cannot lend as much, which reduces the overall money supply in the economy. As a result, this action would lead to higher interest rates, which tend to reduce borrowing and, hence, spending, shifting aggregate demand left.
This ultimately contributes to a lower price level and potentially a lower real GDP in the short run. Contrastingly, reducing interest rates or reserve requirements would be strategies used in an expansionary monetary policy to increase the money supply and stimulate the economy.
Another option to enact contractionary monetary policy is increasing the discount rate. When the discount rate is raised, it becomes more expensive for banks to borrow money from the Federal Reserve, leading to reduced lending and a decrease in the money supply.