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Difficulty: Very hardMonetary Policy, Fiscal Policy, and Economic Tools

An economic research team notes that the yield curve has recently un-inverted while core inflation remains elevated above target levels. Financial analysts are assessing potential government and central bank measures designed to restrict credit expansion and reduce inflationary pressures. Which of the following policy actions represents a contractionary monetary policy measure strictly controlled by the Federal Reserve Board, rather than a fiscal policy measure enacted by Congress?

  1. Increasing the Interest on Reserve Balances (IORB) rate paid to depository institutionsAnswer
  2. B
    Increasing federal income tax rates on high-earning corporate entities
  3. C
    Decreasing government spending on municipal infrastructure projects
  4. D
    Lowering the discount rate charged to member banks borrowing at the Federal Reserve lending window

Answer

Increasing the Interest on Reserve Balances (IORB) rate paid to depository institutions
Increasing the Interest on Reserve Balances (IORB) rate is a contractionary monetary policy tool administered directly by the Federal Reserve Board. Higher IORB rates incentivize banking institutions to retain funds at the central bank rather than issuing loans, restricting money supply expansion.

Step-by-Step Solution

1
Identify policy jurisdiction (Monetary vs. Fiscal)
Monetary policy is conducted by the Federal Reserve Board (FRB), whereas fiscal policy involves taxation and spending decisions passed by Congress.
The question specifically asks for a monetary policy measure controlled strictly by the Federal Reserve.
2
Determine policy direction (Contractionary vs. Expansionary)
To cool elevated inflation, policy measures must be contractionary (tightening the money supply and curbing credit expansion).
Contracting money availability increases borrowing costs, slowing demand and inflation.
3
Evaluate Federal Reserve tools
Raising the IORB rate incentivizes commercial banks to keep excess funds on deposit at the Fed rather than extending loans to consumers and businesses, effectively contracting credit availability.
IORB is a key modern administrative monetary policy tool utilized by the Fed to tighten monetary conditions.

Key Concept

Distinction between Federal Reserve monetary policy tools (IORB, discount rate, open market operations, reserve requirements) and Congressional fiscal policy tools (taxation, spending).
Estimated Time:1m 30s
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Topics

Monetary Policy, Fiscal Policy, and Economic Tools

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