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Assume that the economy is at full employment and is experiencing rapid inflation. Which of the following combinations of monetary and fiscal policies would reduce inflation most, assuming the dollar values for both policy changes are the same amount?
A. Buy government securities, Increase the federal budget deficit
B. Buy government securities, Decrease the federal budget deficit
C. Sell government securities, Increase the federal budget deficit
D. Sell government securities, Decrease the federal budget deficit
Solution
VerifiedControlling inflation is one of the main responsibilities of the central bank and the government. Reducing inflation can be done through monetary or fiscal policies such as:
- Reducing government spending
- Increasing taxes, and thus reducing consumption
- Increasing the reserve ratio
- Increasing the interest rates
- Increasing the discount rate
- Selling government securities
When government securities are sold on the open market the money supply will be reduced as more bonds will be issued, and less money will be in circulation, as bonds are not part of the money supply. Thus, a good monetary policy to reduce inflation is selling government securities.
The federal budget deficit if the difference between tax revenue and spending. By reducing government spending and/or increasing taxes, the federal budget deficit can be decreased. Thus, decreasing the federal budget deficit is a good fiscal policy.
Therefore, the correct option is D.
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