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Difficulty: EasyMonetary Policy, Fiscal Policy, and Economic Tools

To slow economic expansion and curb rising inflation, the Federal Reserve intends to contract the money supply. Which of the following actions is a monetary policy tool available to the Federal Reserve for this purpose?

  1. Increasing the discount rate charged to depository institutionsAnswer
  2. B
    Increasing federal corporate tax rates
  3. C
    Decreasing federal government spending on infrastructure programs
  4. D
    Increasing government transfer payments to low-income households

Answer

Increasing the discount rate charged to depository institutions is a Federal Reserve monetary policy action that contracts the money supply.
Increasing the discount rate is an official monetary policy tool set by the Federal Reserve. Raising this interest rate makes borrowing more expensive for banks, which reduces overall money supply growth and helps temper inflation.

Step-by-Step Solution

1
Distinguish monetary policy tools from fiscal policy tools
Monetary policy is controlled by the Federal Reserve (open market operations, reserve requirements, discount rate, interest on reserve balances), whereas fiscal policy involves taxation and government spending set by Congress.
The question specifically asks for a Federal Reserve monetary policy tool.
2
Identify the impact of raising the discount rate
Raising the discount rate increases the cost for commercial banks to borrow from the Fed, discouraging lending and tightening/contracting the money supply.
Higher borrowing costs for financial institutions help cool an overheating economy and curb inflation.

Key Concept

Distinguishing Monetary Policy (Federal Reserve actions) from Fiscal Policy (Congressional taxation and spending)
Estimated Time:45s
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Topics

Monetary Policy, Fiscal Policy, and Economic Tools

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