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Suppose a country is facing an inflationary gap, and the Central wants to use monetary policy...

Suppose a country is facing an inflationary gap, and the Central wants to use monetary policy to stabilize the economy. What kind of policy should it follow? How will it impact bond prices, interest rates, investment, the exchange rate, net exports, real GDP, and the price level. Illustrate your analysis graphically with explanations.

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Central bank use contractionary monetary policy to fill the inflationary gap contractionary monetary policy reduces aggregate demand and shift demand curve leftward from AD to AD' which reduce output to its potential level from Y to Y​​​​​​p​​​​​ it reduces price level from P to P' and reduces real GDP contractionary monetary policy negatively impact exporters and reduces net exports it raises interest rates and reduce bond prices which tends to reduce investment. Investment and net export falls aggregate demand falls contractionary monetary policy cause increase in exchange rate as it increases demand for domestic currency and reduce demand for foreign currency.

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