NASAA Series 65, Uniform Investment Adviser Law ExaminationEconomic Factors and Business InformationMedium
A central bank is concerned about rising inflation and decides to implement a policy to cool down the economy. Which of the following actions would be considered a contractionary monetary policy?
- ALowering the reserve requirement for banks
- BPurchasing government securities in the open market
- CIncreasing the discount rate
- DDecreasing the federal funds rate target
Show answer & explanationAnswer & explanation
Correct answer: C. Increasing the discount rate
Increasing the discount rate makes it more expensive for banks to borrow from the central bank, thereby reducing the money supply and slowing economic activity, which is a contractionary monetary policy.
Why the other options are wrong
- A. Lowering the reserve requirement is an expansionary policy.
- B. Purchasing government securities (Quantitative Easing) is an expansionary policy.
- D. Decreasing the federal funds rate target is an expansionary policy.
Contractionary Monetary Policy
Contractionary monetary policy is used by central banks to slow down economic growth, typically to combat inflation, by decreasing the money supply and increasing interest rates.
- Aims to reduce inflation
- Involves decreasing money supply
- Increases interest rates
Memory trick: Rates Up, Money Down, Economy Cools.