Suppose the Fed's primary goal is price stability and it aims to keep the inflation rate at 2%. If the inflation rate rose above 2%, what should it do?
A) pursue an expansionary monetary policy
B) pursue a contractionary monetary policy
C) reduce the required reserve ratio
D) impose a temporary ceiling on the federal funds rate

Question

Quizplus · Accepted Answer

If the inflation rate rose above 2%, the Fed should pursue a contractionary monetary policy to decrease the money supply, increase interest rates, and reduce aggregate demand. This could be achieved through measures such as selling government securities, raising the discount rate, or increasing the reserve requirement. A temporary ceiling on the federal funds rate or reducing the required reserve ratio would have the opposite effect and could exacerbate inflationary pressures. Pursuing an expansionary monetary policy would further increase inflation, so it is not a suitable option in this scenario.

Suppose the Fed's Primary Goal Is Price Stability and It