Principles of Macroeconomics / Unit 12 MAC 1121 worked example, 60 to 90 seconds
Which Tool, Which Direction
The idea
Given a goal, name an action that serves it and say which way each variable moves. Expansionary actions add reserves or make them cheaper; contractionary actions do the reverse. Work each one through to the interest rate before judging it.
In practice
To expand: buy bonds, which raises reserves, lowers the federal funds rate and raises aggregate demand. To contract: sell bonds, which drains reserves and raises the rate. Lowering the discount rate is expansionary and weakly so, since the window is little used. Lowering a reserve requirement would be expansionary, and raising it contractionary. Now the case the exam asks: to fight inflation the central bank contracts, so it reduces the money supply by selling bonds. Note the trap in the alternatives, because lowering the required reserve ratio is expansionary and would worsen inflation, and that ratio has been zero since March 2020 in any case.
Where people slip
An open market sale is contractionary, and unit nine's Phillips curve shows what that looks like from the other side: a movement along the short-run curve toward lower inflation and higher unemployment. The same action, two diagrams, one story.
Your place on the trail
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