During an economic boom, which government policy is used to reduce aggregate demand?

During an economic boom, which government policy is used to reduce aggregate demand?

• A. Increase public expenditure
• B. Raise taxes to reduce spending
• C. Decrease interest rates
• D. Run a budget deficit

Answer: (B)

During an economic boom, the aim is to cool excess demand and prevent inflation, so policymakers use contractionary measures that reduce aggregate demand. Raising taxes to reduce spending does this by cutting households’ disposable income, which lowers consumer spending, and can also dampen business investment, overall pulling AD to the left. In contrast, increasing public expenditure would boost aggregate demand; lowering interest rates would stimulate borrowing and spending; and running a budget deficit is expansionary, further increasing aggregate demand. So raising taxes to reduce spending is the most appropriate tool to dampen demand during a boom.

During an economic boom, the aim is to cool excess demand and prevent inflation, so policymakers use contractionary measures that reduce aggregate demand. Raising taxes to reduce spending does this by cutting households’ disposable income, which lowers consumer spending, and can also dampen business investment, overall pulling AD to the left. In contrast, increasing public expenditure would boost aggregate demand; lowering interest rates would stimulate borrowing and spending; and running a budget deficit is expansionary, further increasing aggregate demand. So raising taxes to reduce spending is the most appropriate tool to dampen demand during a boom.