Contractionary Policies to Curb Aggregate Demand

Steps:

• Identify goal: Prevent inflation by reducing aggregate demand (AD) in short run.
• Fiscal policy: Decreasing budget deficit is contractionary (cuts G or raises T, lowers AD); increasing deficit is expansionary (raises AD).
• Monetary policy: Decreasing money supply is contractionary (raises interest rates, cuts investment and AD); decreasing interest rate is expansionary (boosts investment and AD).
• Effective combo: Both policies contractionary to shift AD left, stabilizing prices.

Why B is correct:

• Combines contractionary fiscal (decrease deficit) and monetary (decrease money supply) policies, reducing AD per IS-LM model in closed economy.

Why the others are wrong:

• A: Expansionary monetary (decrease interest rate) offsets contractionary fiscal, insufficient AD reduction.
• C: Both expansionary, increases AD and worsens inflation.
• D: Expansionary fiscal (increase deficit) offsets contractionary monetary, net AD effect unclear or positive.

Final answer: B