Question

If policymakers are concerned that the economy is in danger of rising inflation because aggregate demand is increasing faster than aggregate​ supply, the appropriate fiscal policy response is to
A) increase taxes.B) increase government spending.C) use expansionary fiscal policy.D) increase interest rates.

Answer 1

Answer: Option (A) is correct.

Explanation:

If there is a higher inflation rate in an economy and it is still rising because aggregate demand is rising at a faster rate than an aggregate supply.

So, there is a need to use contractionary fiscal policy. If the government increase taxes then as a result aggregate demand decreases. This is because of the fall in disposable income, with less income in hand consumers demand for the goods decreases.

Hence, this contractionary fiscal policy will help government to reduce inflation to some extent.