Which of the following combinations of policies is designed to decrease inflation?

• A. Increase interest rates and decrease government spending
• B. Decrease interest rates and decrease government spending
• C. Decrease interest rates and increase government spending
• D. Increase government spending and decrease taxes

Answer: (A)

Verified step by step guidance

1. Step 1: Understand that inflation is generally caused by demand-pull factors, where aggregate demand exceeds aggregate supply, leading to upward pressure on prices.
2. Step 2: Recognize that increasing interest rates is a monetary policy tool used to reduce inflation by making borrowing more expensive, which lowers consumer spending and investment, thus reducing aggregate demand.
3. Step 3: Understand that decreasing government spending is a fiscal policy tool that reduces aggregate demand by lowering overall government expenditures in the economy.
4. Step 4: Combine these two policies—increasing interest rates and decreasing government spending—to effectively reduce aggregate demand, which helps to decrease inflationary pressures.
5. Step 5: Evaluate the other options by considering how decreasing interest rates or increasing government spending would typically increase aggregate demand and potentially raise inflation, which is the opposite of the goal.