SIE Economic Factors and Business Cycles 2 — Questions and Answers
Question 1: Which of the following is the Federal Reserve's primary tool for implementing monetary policy?
- Setting federal income tax rates
- Controlling government spending levels
- Adjusting the federal funds rate (Correct answer)
- Imposing import tariffs on foreign goods
Correct answer: Adjusting the federal funds rate
The Federal Reserve primarily uses the federal funds rate — the rate at which banks lend to each other overnight — as its main tool to influence monetary conditions.
Question 2: When the Federal Reserve raises interest rates, what is the typical effect on existing fixed-rate bond prices?
- Bond prices increase
- Bond prices decrease (Correct answer)
- Bond prices remain unchanged
- Bond prices become uncorrelated with rates
Correct answer: Bond prices decrease
When interest rates rise, existing bonds paying lower fixed rates become less attractive compared to new bonds, causing their market prices to fall.
Question 3: Expansionary fiscal policy is best described as:
- Increasing taxes and reducing government spending to reduce deficits
- The Federal Reserve selling Treasury securities to reduce the money supply
- Decreasing taxes and/or increasing government spending to stimulate the economy (Correct answer)
- Raising the federal funds rate to slow borrowing
Correct answer: Decreasing taxes and/or increasing government spending to stimulate the economy
Expansionary fiscal policy uses lower taxes and/or higher government spending to inject money into the economy and stimulate growth, especially during recessions.
Question 4: Open market operations conducted by the Federal Reserve refer to:
- Regulating the hours that stock exchanges are open
- The Fed's purchase or sale of U.S. government securities to influence the money supply (Correct answer)
- Setting margin requirements for securities purchases
- Issuing new U.S. Treasury bonds to fund the federal deficit
Correct answer: The Fed's purchase or sale of U.S. government securities to influence the money supply
Open market operations involve the Federal Reserve buying or selling U.S. government securities to expand or contract the money supply and influence interest rates.
Question 5: To combat rising inflation, the Federal Reserve would most likely:
- Lower the reserve requirement for member banks
- Purchase government securities on the open market
- Lower the discount rate charged to member banks
- Sell government securities on the open market (Correct answer)
Correct answer: Sell government securities on the open market
Selling government securities withdraws money from the banking system, reducing the money supply and raising interest rates, which slows inflation.
Question 6: The discount rate is best defined as:
- The interest rate banks charge their most creditworthy corporate customers
- The rate at which the Federal Reserve lends money to member banks (Correct answer)
- The yield on 90-day U.S. Treasury bills
- The rate at which banks lend to each other overnight
Correct answer: The rate at which the Federal Reserve lends money to member banks
The discount rate is the interest rate the Federal Reserve charges commercial banks when they borrow directly from the Fed's discount window.
Question 7: When the Federal Reserve purchases government securities through open market operations, the effect on the money supply is:
- The money supply decreases
- The money supply remains unchanged
- The money supply increases (Correct answer)
- The money supply becomes more volatile but does not change in size
Correct answer: The money supply increases
When the Fed buys government securities, it pays for them by crediting bank accounts, injecting money into the banking system and increasing the money supply.
SIE Economic Factors and Business Cycles 2
Which of the following is the Federal Reserve's primary tool for implementing monetary policy?