Expansionary Policies to Boost Aggregate Demand

Steps:

• Deflation signals weak aggregate demand, causing falling prices.
• Effective short-run policies increase AD to raise output and prices.
• Expansionary fiscal policy involves increasing the budget deficit via higher spending or lower taxes.
• Expansionary monetary policy lowers interest rates to stimulate investment and consumption.

Why C is correct:

• Increasing the budget deficit (fiscal expansion) and decreasing interest rates (monetary expansion) both shift AD rightward in the AD-AS model, countering deflation by raising price levels.

Why the others are wrong:

• A: Decreasing the budget deficit contracts fiscal policy, reducing AD and exacerbating deflation despite monetary easing.
• B: Both decreasing deficit and money supply are contractionary, shrinking AD and worsening deflation.
• D: Decreasing money supply contracts monetary policy, raising rates and offsetting fiscal expansion's AD boost.

Final answer: C