Which of the following monetary and fiscal policy combinations would most likely

Question

Which of the following monetary and fiscal policy combinations would most likely result in a decrease in aggregate demand: a. A lower discount rate; an open-market purchase by the Fed; and an increase in federal government spending. b. A higher discount rate; an open-market sale by the Fed; and a decrease in federal government spending. c. A lower discount rate; an open-market sale by the Fed; and a decrease in federal government spending. d. A higher discount rate; an open-market purchase by the Fed; and an increase in federal government spending

Explanation / Answer

Ans: b. A higher discount rate; an open-market sale by the Fed; and a decrease in federal government spending.

Explanation:

A higher discount rate makes borrowing from Fed costlier. So, banks can not able to borrow more money from Fed and also not able to give loans to public. This leads to decrease in money supply in the economy which ultimately leads to decrease in aggregate demand.

When Fed sales bond through open market operation, money flows from the hands of people to the hand of FED which leads to decrease in money supply in the economy which ultimately leads to decrease in aggregate demand.

When government spending decreases, this also leads to decrease in aggregate demand.

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