Boosting Aggregate Demand to Combat Deflation

Steps:

• Deflation arises from insufficient aggregate demand (AD) relative to aggregate supply (AS), causing falling prices.
• Policies to prevent deflation must shift AD rightward via increased spending or income.
• Assess each option's effect on consumption, investment, or net exports.
• Select the option that most directly raises household spending.

Why C is correct:

• Transfer payments increase disposable income for lower-income groups, directly boosting consumption expenditure in the AD formula (AD = C + I + G + NX), per Keynesian economics.

Why the others are wrong:

• A: Higher income taxes reduce disposable income, lowering consumption and AD.
• B: Higher interest rates raise borrowing costs, discouraging investment and consumption, further reducing AD.
• D: Currency devaluation boosts exports but raises import prices, with uncertain net AD impact due to inflation risks.

Final answer: C