Assume a Central Bank Has Been Charged with Maintaining the Price

Multiple Choice

Assume a central bank has been charged with maintaining the price level at a rate of 2 per cent. For the past twelve months the inflation rate has been at target and interest rates have been stable but the government has been concerned over signs of a slowdown in economic activity. As a result the government has decided to increase its spending on infrastructure projects. If the central bank wishes to maintain interest rates (and inflation) at a stable rate what should it do in the light if this decision?

A) Nothing as changes in government spending on infrastructure does not affect consumer price inflation.
B) Expand the money supply to maintain interest rates at a level consistent with its forecast of consumer price inflation.
C) Reduce the money supply by an equal amount to counteract the increase in government spending.
D) Persuade the government that any additional spending must be financed purely by taxation so that monetary policy does not have to change.