Question

Which sentence best completes the diagram?

Answer 1

A central bank raising interest rates on reserves tends to make banks less likely to lend money. Higher interest rates on reserves incentivize banks to hold onto funds rather than lending them out. The statement that best completes the diagram is A. Banks are less likely to lend money.

When a central bank increases interest rates on reserves, it typically discourages banks from lending money. The rationale behind this is that higher interest rates on reserves provide an attractive incentive for banks to hold onto funds, rather than extending loans.

This policy aims to control inflation and stabilize the economy by limiting the availability of credit. As banks are less inclined to lend, it can have a cascading effect on economic activity, influencing investment and spending. Consequently, the central bank's decision to raise interest rates on reserves is a strategic move to manage monetary conditions and shape the overall financial landscape.

Option A is correct.

Answer 2

Original Question: A central bank raises interest rates on reserves

Answer: Investors are less likely to purchase bonds:

Reason: When the economy is good, the level of borrowing money becomes extraordinarily high since there is confidence in the market.

As in, people believe that they can return the money back to the bank since there is a high chance of making the money back up again at a profit.

However, as more and more people do that, the economy heads into state of inflation.

To ensure that the inflation rate doesn't go up sky-high, central banks raise the interest rate on loans which discourages investors to get loans or bonds due to how much they need to pay back later on.

Hope that helps!