Suppose that you are employed as an advisor to the central bank. Select the proper policy recommendation or economic prediction for each of the following scenarios.
Which policy is appropriate when a rising aggregate price level is a concern but GDP is growing at an acceptable rate?
- expansionary monetary policy (easy money policy)
- It is unclear which type of monetary policy is appropriate.
- contractionary or restrictive monetary policy (tight money policy)

Which policy is appropriate when a rising aggregate price level is a concern and GDP is not growing at an acceptable rate?
- It is unclear which type of monetary policy is appropriate.
- expansionary monetary policy (easy money policy)
- contractionary or restrictive monetary policy (tight money policy)

Contractionary or restrictive monetary policy (tight money policy) will cause interest rates to
- decrease.
- increase sometimes and decrease sometimes.
- increase.

Recall that monetary policy typically implies a tradeoff between GDP and inflation. This can be illustrated with a graph depicting aggregate demand (AD) and aggregate supply (AS).

Expansionary monetary policy describes actions that increase the money supply. As more money is put into circulation, the interest rate declines, and consumption and investment spending increase. Thus, expansionary monetary policy causes the AD curve to shift to the right. This increases GDP but also implies that the price level rises (also known as inflation). Contractionary monetary policy has the opposite impact: a decrease in GDP and a decrease in the price level.

For the first scenario, contractionary monetary policy is appropriate. This type of policy response would address concerns of inflation. The downward pressure on GDP is not too troubling because GDP is said to be growing at an acceptable rate.

For the second scenario, it is unclear how monetary policy should be used. Expansionary monetary policy would help stimulate GDP but would exacerbate the problems associated with inflation. Contractionary monetary policy would help with inflation but would worsen the lack of economic growth.

Contractionary monetary policy causes interest rates to increase.