Why does contractionary monetary policy decrease output? Describe the stages that link monetary policy to output. This is known as the transmission mechanism.
a) Contractionary monetary policy decreases output by reducing the money supply, which leads to higher interest rates.
b) Higher interest rates increase the cost of borrowing for consumers and businesses, reducing investment and spending.
c) Reduced investment and spending lead to lower aggregate demand, resulting in decreased production and output.
d) Lower production and output result in lower employment and income, leading to a decrease in overall economic activity.