Monetary Policy to Stimulate Demand in Deflation

Steps:

• Deflation is a sustained decrease in price levels, reducing consumer spending and economic activity.
• Reflation aims to reverse this by increasing aggregate demand through policy measures.
• Fiscal policies like taxes or spending affect demand but are slower and less targeted for quick inflation boosts.
• Monetary policy, such as adjusting interest rates, directly influences borrowing and investment to expand the money supply.

Why C is correct:

• Reducing interest rates lowers borrowing costs, encouraging investment and consumption per the liquidity preference theory, which boosts money supply and demand to counter deflation.

Why the others are wrong:

• A. Increasing corporation tax reduces business profits and investment, worsening economic contraction.
• B. Increasing income tax cuts disposable income, further discouraging spending and deepening deflation.
• D. Reducing spending on education decreases government outlays, contracting fiscal stimulus and aggregate demand.

Final answer: C