Question

Suppose the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential real gross domestic product?
A. decrease unemployment insurance benefits
B. decrease marginal tax rate
C. increase the discount rate
D. have the Federal Reserve sell government bonds

Answer 1

Answer:

D. have the Federal Reserve sell government bonds

Explanation:

In inflationary processes, the Federal Reserve must act to regularize the economy. This is done through monetary policy instruments.

The sale of government bonds by the Federal Reserve is a contractionary monetary policy, that is, it aims to remove money from circulation in the economy. Since inflation is a monetary phenomenon caused by excess currency in circulation, bond sales will cause agents to send money to the FED in exchange for the securities. Inflation tends to decrease and the economy will return to the functional level where real GDP will be closer to its potential.