Question

A reduction in inflation can best be achieved by which of the following combinations of fiscal and monetary policy?

A) Fiscal: increase taxes ; monetary: sell government bonds
B) Fiscal: decrease taxes ; monetary: lower margin requirements
C) Fiscal: decrease taxes ; monetary: lower margin requirements
D) Fiscal: decrease government spending ; monetary: lower discount rate
E) Fiscal: increase government spending; monetary: raise discount rate

Answer 1

The best combination of fiscal and monetary policy to achieve a reduction in inflation is to increase government spending and raise the discount rate.

Step-by-step explanation:

The combination of fiscal and monetary policy that can best achieve a reduction in inflation is option E: Fiscal: increase government spending; monetary: raise discount rate.

A reduction in inflation occurs when there is less money in circulation. In this combination, increasing government spending will directly inject money into the economy, while raising the discount rate will make borrowing money from the central bank more expensive, leading to decreased money supply. Both actions help reduce inflation.

For example, suppose the government increases spending on infrastructure projects, such as building roads and bridges. This leads to more money flowing into the economy, which can stimulate economic growth. At the same time, the central bank raises the discount rate, which makes it more expensive for banks to borrow money for lending purposes. As a result, banks may reduce lending, leading to a decrease in the money supply and ultimately reducing inflation.