-In this situation, we want a tight money policy. To do this, we can 1) sell government securities, 2) increase the reserve ratio, or 3) increase the discount rate. All three of these will decrease the supply of money. -If supply of money decreases, then the rate of interest increases. Then, when the rate of interest increases, the amount of investment decreases. -Then, since investment decreases, aggregate expenditures (C+Ig+G+Xn) decreases. That then shifts the GDP down by the change times the multiplier. Finally, when GDP decreases, price level will drop (since the economy most likely is in the vertical range of the aggregate supply curve) and therefore inflation will decrease.

Inflationary Situation