Monetary Policy's Impact on Aggregate Supply

Steps:

• Raising interest rates curbs inflation by reducing aggregate demand through higher borrowing costs.
• Higher rates also raise costs for businesses to invest in production capacity.
• This can shift the aggregate supply curve leftward, causing supply shortages.
• Governments avoid this to prevent stagflation or output contraction.

Why B is correct:

• In the AS-AD model, higher interest rates increase production costs (e.g., debt servicing for capital), reducing short-run aggregate supply and potentially worsening inflation via cost-push effects.

Why the others are wrong:

• A: Raising rates intentionally reduces aggregate demand to fight inflation, so it succeeds, not fails.
• C: Higher interest rates incentivize saving by offering better returns, so saving rises.
• D: Higher domestic rates attract foreign capital, strengthening (appreciating) the exchange rate, not falling.

Final answer: B