In the context of expansionary and contractionary monetary policy, when inflation is high, the Federal Reserve aims to slow the economy by using which type of policy?

• A. Expansionary fiscal policy (e.g., increasing government spending)
• B. A balanced budget policy (keeping taxes and spending unchanged) specifically designed to reduce inflation
• C. Contractionary monetary policy (e.g., raising the target federal funds rate)
• D. Expansionary monetary policy (e.g., lowering the target federal funds rate)

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the goal of the Federal Reserve when inflation is high. The Fed aims to slow down economic activity to reduce inflationary pressures.
2. Step 2: Recall the difference between expansionary and contractionary monetary policies. Expansionary monetary policy is used to stimulate the economy, while contractionary monetary policy is used to slow it down.
3. Step 3: Identify the tools of monetary policy. The Federal Reserve can influence the economy by adjusting the target federal funds rate, which affects borrowing costs and overall spending.
4. Step 4: Recognize that when inflation is high, the Fed raises the target federal funds rate to make borrowing more expensive, reducing spending and investment, which slows economic growth.
5. Step 5: Conclude that the appropriate policy in this context is contractionary monetary policy, such as raising the target federal funds rate, to combat high inflation.