Economics · Fiscal and Monetary Policy
The government of a country is currently facing high demand-pull inflation and a significant balance of payments deficit. They have decided to implement a policy of 'Interest Rate Smoothing' while simultaneously increasing Direct Taxation. Which of the following describes the most likely impact of these combined actions on the business environment?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1Fiscal policy is being used to manage the money supply, while monetary policy is being used to redistribute income and wealth.
- 2The money supply will expand as a result of higher tax receipts being reinvested into public works, leading to cost-push inflation.
- 3Consumer demand will contract, potentially reducing the balance of payments deficit, though interest rate smoothing may slow the transition to a lower inflation target.✓
- 4Aggregate demand will increase due to the stabilizing effect of interest rate smoothing, while the balance of payments deficit will widen.
Correct answer
Consumer demand will contract, potentially reducing the balance of payments deficit, though interest rate smoothing may slow the transition to a lower inflation target.
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