Question

If the Federal Reserve decides to decrease the money supply, which of the following most likely will occur?

1) A decrease in private investment and an increase in consumer expenditure
2) An increase in private investment and a decrease in consumer expenditure
3) An increase in private investment and consumer expenditure
4) A decrease in private investment and consumer expenditure

Answer 1

If the Federal Reserve decides to decrease the money supply, it will implement a contractionary monetary policy. This results in a decrease in private investment and consumer expenditure.

Step-by-step explanation:

If the Federal Reserve decides to decrease the money supply, it will implement a contractionary monetary policy. This policy involves the central bank selling bonds, which reduces the money supply in the economy. As a result, the interest rates rise, discouraging borrowing for both private investment and consumer expenditure.

Option 4: A decrease in private investment and consumer expenditure is the most likely outcome when the money supply is decreased. Higher interest rates make borrowing more expensive, which reduces private investment. Additionally, consumers are less likely to take out loans for big-ticket items like houses and cars.