Reinforcing contractionary policies reduce aggregate demand

Steps:

• Higher interest rates represent contractionary monetary policy, discouraging borrowing and investment.
• Increased taxes on expenditure represent contractionary fiscal policy, reducing consumer spending.
• Both policies decrease aggregate demand in the economy.
• Lower aggregate demand leads to falling prices, causing deflation.

Why B is correct:

• Contractionary monetary and fiscal policies both reduce spending, reinforcing each other to shift the aggregate demand curve leftward per the AD-AS model.

Why the others are wrong:

• A: Increased taxes are contractionary fiscal policy, not expansionary.
• C: Higher interest rates are contractionary monetary policy, not expansionary.
• D: The policies amplify, rather than cancel, deflationary pressures.

Final answer: B