Combating demand-pull inflation via monetary policy

Steps:

• High inflation (5% vs. 2% target) with low unemployment indicates demand-pull inflation from economic overheating.
• Central banks target inflation using monetary tools to adjust aggregate demand.
• Raising interest rates cools the economy by increasing borrowing costs.
• This reduces spending, investment, and imported inflation pressures.

Why D is correct:

• Increasing interest rates is contractionary monetary policy that raises the cost of borrowing, curbing consumer and business spending to lower aggregate demand and inflation, as per the quantity theory of money (MV = PQ).

Why the others are wrong:

• A: Boosts labor supply and long-term growth but does not directly reduce current demand-pull inflation.
• B: Targets specific consumption (e.g., tobacco) but fails to address broad inflationary pressures.
• C: Raises import prices, potentially exacerbating inflation rather than controlling it.

Final answer: D