Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsEasy
A financial advisor is explaining the role of the Federal Reserve to a new client. Which of the following actions would the Federal Reserve most likely take to stimulate a sluggish economy?
- ASell government securities in the open market.
- BPurchase government securities in the open market.
- CIncrease the reserve requirement for banks.
- DIncrease the federal funds rate target.
Show answer & explanationAnswer & explanation
Correct answer: B. Purchase government securities in the open market.
To stimulate a sluggish economy, the Federal Reserve aims to increase the money supply and encourage lending. Purchasing government securities in the open market injects money into the banking system, lowering interest rates and making it easier for businesses and consumers to borrow and spend.
Why the other options are wrong
- A. Selling government securities would withdraw money from the banking system, tightening monetary policy and slowing the economy.
- C. Increasing the reserve requirement would reduce the amount of money banks can lend, slowing the economy.
- D. Increasing the federal funds rate target would tighten monetary policy and slow down the economy.
Open Market Operations (OMO)
The buying and selling of government securities in the open market by the Federal Reserve to expand or contract the amount of money in the banking system.
- Most frequently used monetary policy tool.
- Buying securities increases money supply (stimulates economy).
- Selling securities decreases money supply (slows economy).
Memory trick: Remember 'Buy' for 'Boost', 'Sell' for 'Slow'.