Contractionary policy curbs inflation by raising interest rates and reducing spending

Steps:

• Contractionary monetary policy involves central banks raising interest rates to decrease money supply.
• Higher interest rates make borrowing costlier, discouraging loans for big purchases like homes and cars.
• This reduces consumer and business spending, slowing economic activity.
• Lower demand eases price pressures, reducing inflation.

Why D is correct:

• Higher interest rates increase returns on savings, incentivizing consumers to save more and spend less, which cools demand-pull inflation per the quantity theory of money (MV = PQ).

Why the others are wrong:

• A: Higher rates lead banks to lend less, not more.
• B: Higher rates raise borrowing costs, lowering disposable income via debt payments.
• C: Monetary policy affects interest rates, not taxes, which are fiscal tools.

Final answer: D