Question

Which of the following correctly describes how contractionary monetary policy will ultimately affect real GDP?

A) Increase real GDP by increasing money supply
B) Decrease real GDP by reducing interest rates
C) Increase real GDP by encouraging borrowing and spending
D) Decrease real GDP by reducing money supply and increasing interest rates

Answer 1

Contractionary monetary policy reduces real GDP by decreasing the money supply and increasing interest rates, decreasing aggregate demand and leading to lower price levels and GDP in the short run.

Step-by-step explanation:

The correct answer to the question of how contractionary monetary policy will ultimately affect real GDP is that it will decrease real GDP by reducing the money supply and increasing interest rates. Contractionary monetary policy involves actions by the central bank to reduce the supply of money and credit in the economy.

This typically leads to higher interest rates, which can discourage borrowing for investment and consumption. As a result, aggregate demand shifts to the left and, at least in the short run, leads to a lower price level and lower real GDP.

In contractionary monetary policy, the central bank causes the supply of money and credit in the economy to decrease, which raises the interest rate, discouraging borrowing for investment and consumption, and shifting aggregate demand left. The result is a lower price level and, at least in the short run, lower real GDP.