Principles of Macroeconomics / Unit 12 MAC 1129 worked example, 60 to 90 seconds
Fighting Inflation: Which Action
The idea
Given inflation as the problem, identify the correct action and say why each alternative fails. The rule is short: fighting inflation means contracting, and contracting means reducing the money supply. Test every option by asking which way it moves aggregate demand.
In practice
Reducing the money supply is contractionary and correct. Buying bonds adds reserves and is expansionary, so it worsens inflation. Lowering the discount rate encourages borrowing and is expansionary. Lowering the required reserve ratio would leave banks more to lend and is expansionary, and that ratio has stood at zero since March 2020, so the option names a lever that is already at its limit. Three of the four alternatives fail for the same reason, which is that they all shift aggregate demand right.
Where people slip
Sorting by direction beats memorising a list, because the exam can name a tool in either direction. Ask what the action does to reserves or to their price, then what that does to the federal funds rate, then which way aggregate demand shifts. The answer follows.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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