Higher interest rates and higher taxes would have which of these effects on the aggregate supply and aggregate demand curves?

A) The aggregate supply curve would shift to the right, while the aggregate demand curve would shift to the left.

B) The aggregate supply curve would shift to the left, while the aggregate demand curve would shift to the right.

C) Both the aggregate supply and aggregate demand curves would shift to the right.

D) Both the aggregate supply and aggregate demand curves would shift to the left.

The correct answer is D.

Considering the IS-LM model, where the IS curve represents the markets of goods and services of the economy and depends negatively on the interest rate, negatively on the tax rate and on other variables of the fiscal policy, the increase of the tax and interest rate would shift the curve to the left. Both variations decrease spending and demand and this is the reason for such shift. If the tax rate is higher, households will have a lower amount of income available to be directed to either consumption or saving. On the other hand, if the interest rate increases, borrowing money becomes more expensive and agents would demand fewer funds in order to spend on investment projects. In turn, consumption and investment levels would decrease and both contribute the shift of the demand curve to the left.

On the other hand, the LM curve which is related to the money market would also shift left due to the decrese in the money supply generated by the increase in interest rates. Therefore, the supply side has also suffered a contraction.