Multiple Choice
Which of the following best describes an automatic stabilizer in fiscal policy?
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19. Fiscal Policy
Introduction to Fiscal Policy
Multiple Choice
Which of the following actions would be consistent with an attempt by the Federal Reserve to reduce inflation?
A
Purchasing government securities in the open market
B
Increasing the federal funds rate
C
Decreasing the reserve requirement
D
Lowering the discount rate
Verified step by step guidance1
Understand that the Federal Reserve (Fed) aims to reduce inflation by implementing contractionary monetary policy, which typically involves reducing the money supply or increasing interest rates to decrease spending and borrowing.
Recall that purchasing government securities in the open market injects money into the economy, increasing the money supply, which is an expansionary policy and would likely increase inflation, so this action is inconsistent with reducing inflation.
Recognize that increasing the federal funds rate raises the cost of borrowing between banks, which tends to increase overall interest rates, reduce borrowing and spending, and thus helps to lower inflation. This action aligns with the Fed's goal to reduce inflation.
Note that decreasing the reserve requirement allows banks to lend more money, increasing the money supply, which is expansionary and would not help reduce inflation.
Understand that lowering the discount rate makes it cheaper for banks to borrow from the Fed, encouraging more lending and increasing the money supply, which is also expansionary and inconsistent with reducing inflation.
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