Which of the following combinations of fiscal and monetary policies is most likely to correct a severe recession?

• A. Contractionary fiscal policy and contractionary monetary policy
• B. Expansionary fiscal policy and contractionary monetary policy
• C. Contractionary fiscal policy and expansionary monetary policy
• D. Expansionary fiscal policy and expansionary monetary policy

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the economic context of a severe recession, which is characterized by high unemployment, low output, and reduced aggregate demand.
2. Step 2: Recall that fiscal policy involves government spending and taxation decisions, where expansionary fiscal policy means increasing government spending or decreasing taxes to boost aggregate demand.
3. Step 3: Recall that monetary policy involves controlling the money supply and interest rates, where expansionary monetary policy means lowering interest rates or increasing the money supply to encourage borrowing and investment.
4. Step 4: Analyze the effects of combining policies: expansionary fiscal policy increases aggregate demand directly, while expansionary monetary policy lowers borrowing costs, further stimulating demand and investment.
5. Step 5: Conclude that to correct a severe recession, both expansionary fiscal and expansionary monetary policies work together to increase aggregate demand and help the economy recover.