Suppose that the economy moves from point A to point B because of increases in costs of production. The central banking authorities respond to the decline in output by implementing an expansionary monetary policy, which causes a further increase in the price level. Costs of production now rise again, however, shifting the economy from point D to point E. The central banking authorities again respond by implementing an expansionary monetary policy, and so on, so that continued increases in aggregate demand cause continued increases in the price level.
Policymakers decide to put a stop to this inflationary spiral. Which of the following might a monetarist economist suggest?
Pursue only a contractionary monetary policy.
Stop the repeated increases in the money supply.
Pursue policies that increase both the money supply and investment.
Target a higher interest rate.