Question

What is an appropriate fiscal policy prescription that addresses the inflation that occurs when the economy is above potential GDP?

A) Increasing government spending
B) Decreasing taxes
C) Reducing interest rates
D) Implementing contractionary fiscal policy

Answer 1

Implementing contractionary fiscal policy through tax increases or government spending cuts is an appropriate fiscal policy prescription to address inflation when the economy is above potential GDP.

Step-by-step explanation:

The appropriate fiscal policy prescription that addresses inflation when the economy is above potential GDP is implementing contractionary fiscal policy. Contractionary fiscal policy involves tax increases or government spending cuts to reduce aggregate demand and lower inflationary pressure. By shifting the aggregate demand (AD) curve to the left, it helps to mitigate inflation without causing significant reduction in output or rise in unemployment.