High and persistent inflation is caused by ________.

• A. falling government spending
• B. a decrease in aggregate demand
• C. temporary supply shocks
• D. continued growth in the money supply

Answer: (D)

Verified step by step guidance

1. Understand the relationship between inflation and the money supply: Inflation occurs when the general price level in an economy rises over time, reducing the purchasing power of money.
2. Recall the Quantity Theory of Money, which states that \(M \times V = P \times Y\), where \(M\) is the money supply, \(V\) is the velocity of money, \(P\) is the price level, and \(Y\) is real output.
3. Recognize that if the money supply (\(M\)) grows faster than real output (\(Y\)), and velocity (\(V\)) is stable, then the price level (\(P\)) must increase, leading to inflation.
4. Analyze the options: falling government spending and a decrease in aggregate demand typically reduce inflationary pressures, while temporary supply shocks cause short-term inflation but not persistent inflation.
5. Conclude that high and persistent inflation is best explained by continued growth in the money supply, as sustained increases in \(M\) lead to ongoing increases in the price level.