Contractionary policies reduce aggregate demand to curb inflation

Steps:

• Inflation rises when aggregate demand (AD) exceeds aggregate supply.
• Contractionary fiscal/monetary policies shift AD leftward, lowering price levels.
• Expansionary policies shift AD rightward, potentially increasing inflation.
• Evaluate each option for its effect on AD.

Why C is correct:

• Reducing interest rates is expansionary monetary policy, lowering borrowing costs and boosting investment/consumption, which increases AD and inflation per the IS-LM model.

Why the others are wrong:

• A: Increasing income tax cuts disposable income, reducing consumption and AD.
• B: Reducing government spending directly decreases AD.
• D: Removing subsidies raises production costs or cuts consumer spending, contracting AD.

Final answer: C