Consumption has fallen substantially in Techland due to pessimism among households. What will be the outcome if a contractionary monetary policy is adopted during this period?
What will be an ideal response?
If a contractionary monetary policy is adopted during this period, consumption and investment will fall further. This is because a fall in money supply will lead to a fall in the aggregate price level. If output prices fall, firms will reduce production and lay off workers. As a result, consumption will fall. Investment will also fall if the government adopts a contractionary monetary policy because a decrease in money supply will lead to an increase in interest rates.
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