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6. (Problem 6) An economy is facing the inflationary gap shown in the accompanying diagram. Aggregate price level LRAS SRAS R

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6) the central bank can use contractionary monetary policy. The interest rate will rise, which would encourage a decrease in investment spending and consumer spending. Real GDP and aggregate price level will both fall (left shift of AD curve).

7) It will buy treasury bills on the open market, so that the money supply will increase, interest rates will fall, planned investment spending will rise, and the AD curve will shift to the right.

8) the Federal Reserve should conduct expansionary monetary policy to lower interest rates, which will shift the aggregate demand curve to the right.

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