Question

The price level falls. This might be because the Federal Reserve

Select one:
a. bought bonds which raised the money supply.
b. bought bonds which reduced the money supply.
c. sold bonds which raised the money supply.
d. sold bonds which reduced the money supply.

Answer 1

The price level fell because the Federal Reserve sold bonds, which reduced the money supply and increased interest rates, resulting in a fall in aggregate demand. Hence, option (d) is correct.

Step-by-step explanation:

When the price level falls, it might be because the Federal Reserve has engaged in contractionary monetary policy, which includes selling bonds, thus reducing the money supply. If the Fed sells bonds, it is effectively decreasing the available amount of money within the banking system as banks use their reserves to purchase these bonds from the Fed. Consequently, the supply of money decreases, leading to an increased interest rate and reduced investment, eventually leading to a fall in aggregate demand.

Therefore, the correct answer to the student's question is that the price level falls likely because the Federal Reserve sold bonds which reduced the money supply.