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Question

Difficulty: MediumMonetary Policy, Fiscal Policy, and Economic Tools

Match each economic policy action on the left with its intended macroeconomic operational effect on the right.

  • The Federal Reserve purchases U.S. Treasury securities in open market operations.Injects reserve liquidity into the banking system to expand the money supply and lower short-term market rates.
  • Congress passes legislation elevating corporate and personal federal income tax rates.Reduces private sector disposable income and consumer demand to cool down over-expanding GDP.
  • The Federal Reserve increases the Interest on Reserve Balances (IORB) rate.Incentivizes commercial banks to hold cash at the central bank, tightening available lending credit.
  • Congress enacts an expansive nationwide public works infrastructure spending program.Directly increases aggregate demand and public sector employment without central bank intervention.

Answer

Open market Treasury purchases inject banking liquidity to expand the money supply; tax increases reduce disposable income to contract fiscal demand; raising the IORB rate incentivizes banks to hold reserves to tighten monetary liquidity; and government infrastructure spending directly stimulates aggregate fiscal demand.
The correct pairings accurately match Federal Reserve monetary tools (open market purchases to expand reserve liquidity, and raising the IORB rate to contract lending capacity) and Congressional fiscal tools (tax hikes to reduce private aggregate demand, and public infrastructure spending to directly boost federal economic output).

Step-by-Step Solution

1
Distinguish between Federal Reserve monetary tools and Congressional fiscal tools.
Identified open market purchases and IORB rate adjustments as monetary policy, and tax adjustments and spending projects as fiscal policy.
Monetary policy regulates money supply and interest rates through the central bank, while fiscal policy manages government revenue and spending through legislative action.
2
Evaluate the direction (expansionary vs. contractionary) and operational mechanism of each monetary policy tool.
Buying Treasuries adds banking reserves (expansionary monetary), whereas raising the IORB rate encourages banks to keep funds at the Fed rather than lending (contractionary monetary).
Central bank asset purchases increase loanable funds, while higher interest rates paid on reserves raise the opportunity cost of commercial lending.
3
Evaluate the direction and operational mechanism of each fiscal policy tool.
Raising tax rates removes funds from households and firms (contractionary fiscal), while direct public works expenditures inject government capital into the economy (expansionary fiscal).
Taxation decreases net disposable income, whereas federal project spending directly impacts output and aggregate demand.

Key Concept

Monetary vs. Fiscal Policy Tools and Transmission Mechanisms
Estimated Time:1m 30s
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Topics

Monetary Policy, Fiscal Policy, and Economic Tools

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