The correct answer is D (it can decrease inflation) as the central goal of all contractionary policies is reducing inflation.


While contractionary fiscal and contractionary monetary policies can increase interest rates (answer A) and decrease available credit (answer B), these are tools used to achieve a higher goal, rather than their final effects. Answers A and B may also be considered as the cons of contractionary policies. Answer C is incorrect because it is an example of either an expansionary monetary or an expansionary fiscal policy.

Aggregate demand is the people’s interest in the gross domestic product of a country that is known as GDP. Controlling it becomes essential as the economy goes through various stages of the growth cycle. Reducing deficit spending and increasing taxes allow the government treasury to prevent economic overheating. In diagrams below, this change is shown by a shift of the AD curve to the left or right, depending on the type of policy used.

A Graph of the Effect of Monetary Policies.
A Graph of the Effect of Monetary Policies (Source: https://macroeconomicanalysis.com)
A Graph of the Effect of Fiscal Policies.
A Graph of the Effect of Fiscal Policies (Source: https://macroeconomicanalysis.com)