Combating deflation with expansionary fiscal policy Steps:

• Negative CPI rates (-2% to -1.4%) signal deflation from weak aggregate demand.
• Price stability requires shifting aggregate demand rightward to raise prices toward zero or target inflation.
• Expansionary fiscal policy increases government spending to boost output and prices via multiplier effect.
• Contractionary monetary policy (higher rates) supports currency peg stability in Bulgaria's fixed exchange rate system, preventing capital outflows.

Why C is correct:

• Increasing government spending expands AD per Keynesian multiplier (ΔY = k * ΔG, where k > 1), countering deflation; higher rates maintain lev-euro peg under currency board rules.

Why the others are wrong:

• A: Decreasing spending contracts AD, worsening deflation.
• B: Increasing rates tightens money supply, but decreasing taxes alone may not offset without direct spending boost.
• D: Both policies contract AD, deepening deflation.

Final answer: C