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Question

Difficulty: MediumMonetary Policy, Fiscal Policy, and Economic Tools

During an economic slowdown, policy makers seek to stimulate growth by expanding the money supply and encouraging bank lending. Which of the following policy actions is a monetary tool controlled by the Federal Reserve to achieve this objective?

  1. Lowering the Interest on Reserve Balances (IORB) rateAnswer
  2. B
    Decreasing corporate income tax rates to incentivize business expansion
  3. C
    Increasing federal appropriations for national infrastructure projects
  4. D
    Reducing the prime rate charged by commercial banks to corporate borrowers

Answer

Lowering the Interest on Reserve Balances (IORB) rate is an expansionary monetary policy tool set directly by the Federal Reserve.
Lowering the Interest on Reserve Balances (IORB) rate is an administrative monetary policy tool of the Federal Reserve. When the Fed lowers this rate, banks earn less interest on money deposited at the central bank, which incentivizes them to extend loans into the economy to seek higher returns.

Step-by-Step Solution

1
Distinguish monetary policy from fiscal policy
Identify that monetary policy involves central bank (Federal Reserve) control of money supply and interest rates, while fiscal policy involves Congressional taxation and government spending.
Tax cuts and infrastructure spending are legislative fiscal actions, eliminating options related to taxation and government spending.
2
Evaluate remaining financial tools and central bank authority
Recognize that the Federal Reserve directly manages administrative rates such as the Interest on Reserve Balances (IORB) rate and discount rate, whereas the prime rate is a commercial bank benchmark rate.
The prime rate is set by commercial banks rather than the central bank.
3
Confirm the economic effect of lowering the IORB rate
Reducing the interest earned on reserve balances makes holding cash at the Fed less attractive, motivating banks to increase lending to consumers and businesses.
This directly supports expansionary monetary objectives during an economic slowdown.

Key Concept

Monetary Policy vs. Fiscal Policy Tools
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Topics

Monetary Policy, Fiscal Policy, and Economic Tools

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