Fiscal Policy Reduces Inflation via Lower Aggregate Demand

Steps:

• Identify inflation as a rise in general price levels due to excess demand or costs.
• Recall that decreasing factors boosting aggregate demand curbs inflationary pressures.
• Evaluate each option's effect on demand or costs when decreased.
• Select the option that directly lowers government-induced demand.

Why A is correct:

• A budget deficit occurs when government spending exceeds revenue; decreasing it reduces excess spending in the economy, lowering aggregate demand per the Keynesian model and thus curbing inflation.

Why the others are wrong:

• B: Decreasing direct taxes raises disposable income, increasing consumer spending and aggregate demand, which accelerates inflation.
• C: Decreasing the exchange rate depreciates the currency, raising import costs and cost-push inflation.
• D: Decreasing interest rates lowers borrowing costs, stimulating investment and consumption, which boosts demand-pull inflation.

Final answer: A