When inflation begins to climb to unacceptable levels in the economy, the government should:

• A. Lower interest rates to encourage borrowing and investment.
• B. Reduce taxes to boost consumer spending.
• C. Implement contractionary monetary or fiscal policies to reduce aggregate demand.
• D. Increase government spending to stimulate economic growth.

Answer: (C)

Verified step by step guidance

1. Understand that when inflation rises to unacceptable levels, the goal of the government or central bank is to reduce inflation by decreasing aggregate demand in the economy.
2. Recall that contractionary monetary policy involves actions such as increasing interest rates, which makes borrowing more expensive and reduces investment and consumption.
3. Recognize that contractionary fiscal policy includes reducing government spending or increasing taxes, both of which decrease overall demand in the economy.
4. Analyze why lowering interest rates or reducing taxes would be inappropriate in this context, as these actions tend to increase aggregate demand and could worsen inflation.
5. Conclude that the correct approach to combat high inflation is to implement contractionary policies that reduce aggregate demand, thereby helping to bring inflation back to acceptable levels.