Final answer:
The Federal Reserve should raise interest rates to lower high inflation. Changing the federal funds rate influences the cost of borrowing, impacting overall economic activity and inflation levels. Historical examples show the effectiveness of this method. The correct option is a.
Step-by-step explanation:
If the inflation rate is high and the Federal Reserve seeks to best lower the inflation rate, the Federal Reserve should raise interest rates. When the Fed raises interest rates, it increases the federal funds rate, which in turn increases the cost of borrowing for banks. These higher costs are passed on to businesses and consumers, resulting in less borrowing and spending, which can help to curb inflation.
Historical examples highlight how the Federal Reserve has previously addressed inflation concerns. For instance, in Episodes 5 and 6, the Fed perceived a risk of inflation and responded by raising the federal funds rate from 3% to 5.8% between 1993 and 1995. This action did not cause a rise in inflation and allowed economic growth to continue. In contrast, a lower interest rate is typically pursued when the problem is slow economic growth or a recession, as it encourages more borrowing and spending.
Overall, the Federal Reserve uses interest rate adjustments as a tool to balance inflation and economic activity. A high interest rate can help control inflation, but it may also lead to slower economic growth. Consequently, the Fed aims to strike a balance between preventing inflation from getting too high and avoiding a slowdown in economic activity.