To stop the economy from overheating as the Vietnam War escalated after 1965, th

Question

To stop the economy from overheating as the Vietnam War escalated after 1965, the Fed could have opted for:

B. A. A low interest rate policy to expand the demand for output, lowering the unemployment rate and lowering the inflation rate.

C. A low interest rate policy to expand the supply of output and prevent the inflation rate from rising.

D. A high interest rate policy to expand the demand for output, raising the unemployment rate and lowering the inflation rate.

E. A high interest rate policy to contract the demand for output, raising the unemployment rate and lowering the inflation rate.

F. A low interest rate policy to contract the supply of output and prevent the unemployment rate from falling.

B. A. A low interest rate policy to expand the demand for output, lowering the unemployment rate and lowering the inflation rate.

C. A low interest rate policy to expand the supply of output and prevent the inflation rate from rising.

D. A high interest rate policy to expand the demand for output, raising the unemployment rate and lowering the inflation rate.

E. A high interest rate policy to contract the demand for output, raising the unemployment rate and lowering the inflation rate.

F. A low interest rate policy to contract the supply of output and prevent the unemployment rate from falling.

Explanation / Answer

Because the aim was to prevent overheating (or inflatonary gap), aggregate demand should have been reduced. This could have been done by increasing the rate of interest via reduced money supply, decreasing AD and thus, inflation would have fallen while unemployment would have rise.

Option E is correct

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