Expansionary Policies to Boost Aggregate Demand

Steps:

• Deflation occurs when aggregate demand (AD) falls, causing prices to drop.
• To prevent it, implement expansionary monetary policy by decreasing interest rates to lower borrowing costs and encourage spending/investment.
• Pair with expansionary fiscal policy by increasing government spending to directly inject money into the economy.
• This combination shifts the AD curve rightward, raising prices and output.

Why C is correct:

• Decreasing interest rates stimulates private spending via cheaper loans, while increasing government spending raises AD directly, countering deflation per the Keynesian AD-AS model.

Why the others are wrong:

• A: Increasing rates contracts monetary policy, reducing AD and offsetting spending gains.
• B: Both policies are contractionary, further lowering AD and exacerbating deflation.
• D: Decreasing spending contracts fiscal policy, undermining the expansionary effect of lower rates.

Final answer: C