The central bank sets an inflation target of 2%. If inflation rises above 2%, the bank would most likely
Question 1 Report
The central bank sets an inflation target of 2%. If inflation rises above 2%, the bank would most likely
Answer Details
An inflation target gives the central bank a clear benchmark for price stability. When inflation exceeds the target, the bank must act to bring it back down.
The correct answer is raise interest rates to reduce aggregate demand. Higher interest rates increase the cost of borrowing and make saving more attractive, which reduces consumer spending and business investment. The resulting fall in aggregate demand eases the upward pressure on prices, helping to bring inflation back toward the 2% target.
Lowering interest rates to encourage spending would increase aggregate demand and push inflation further above target. Printing more money would increase the money supply and fuel further inflation rather than reducing it. Increasing government spending is a fiscal policy measure, not a monetary policy action, and would also add to aggregate demand.
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