Which of the following actions is acknowledged preventive measure for a period of deflation?
a. Increasing interest rates
b. Increasing the money supply
c. Decreasing interest rates
d. Decreasing the money supply
Answer:B
Choice “b” is correct. Deflation is a general decline in the overall price level (i.e., when the inflation rate is negative). Increasing the money supply causes the overall price level to rise. As a result, it helps eliminate deflation.
Choice “a” is incorrect. Increasing interest rate causes aggregate demand to shift left. As a result, the aggregate price level will fall even further. This will exacerbate deflation.
Choice “c” is incorrect. While this answer choice also counteracts deflation,
choice “b” is the best answer. A decrease in interest rates causes the aggregate demand curve to shift right. As a result, the aggregate price level will rise. This helps eliminate deflation. However, there are times when interest rates are already so low that lowering interest rates is not an option. Thus, the preferred or “acknowledged” preventative measure for deflation is increasing the money supply. Choice “d” is incorrect. Decreasing the money supply causes the overall price level to fall. This would obviously exacerbate deflation.