Question

Which statement lists contractionary policies? Question 73 options: a) The Fed purchases bonds, lowers the discount rate, and lowers the reserve requirements. b) The Fed sells bonds, raises the discount rate, and raises the reserve requirements. c) The Fed sells bonds, lowers the discount rate, and raises the reserve requirements. d) The Fed sells bonds, lowers the discount rate, and lowers the reserve requirements.

Answer 1

The correct answer is letter B.

Explanation:

Contractionary monetary policies are instruments used by the FED to decrease the amount of money in an economy. There are three classic instruments of monetary policy: open market, rediscount policy and compulsory deposit. The open market is about buying and selling federal government bonds. Thus, by selling bonds, the bank will be increasing the supply of bonds in the economy, on the other hand, is withdrawing dollars, that is, will be withdrawing currency from the economy, resulting in a contractionary monetary policy. Rediscount refers to the interest rate on loans that the FED lends to financial institutions. In situations of illiquidity, banks turn to the FED for loans. In this case, the FED, by increasing the rediscount rate, hindering the supply of money to the institutions and thus exerting a contractionary monetary policy. Finally, bank reserves refer to the part of banks' monetary reserves that are required to be deposited with the FED. Thus, by increasing the percentage of such reserves, the FED is exerting a contractionary fiscal policy, as it decreases the total amount of commercial banks' borrowing resources.