To reduce inflation, the federal reserve the money supply. this action also causes the economy to shrink..a. increases. b. decreases. c. does not change

The correct answer is B.

If aiming to reduce inflation, the Federal reserve needs to decrease the money supply, which means reducing the amount of money in circulation in the economy. This is denominated a contractionary monetary policy.

If the money supplied decreases, the cost of borrowing (the cost of money) increases due to its increased relative scarcity. This, in turn, discourages borrowing, and produces a lower income, and a drop in demand, production, and employment. Therefore, it causes the economy to shrink as mentioned in the question.

As spending drops, so do prices and therefore inflation.

Such a strategy is only implemented when there are inflationary preassures, as it also brings important side effects in terms of output.

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