The Role of the Central Bank

Which of the following is the primary objective of monetary policy conducted by a central bank?

• To reduce the level of government borrowing by cutting public expenditure

• To control inflation by adjusting interest rates and the money supply

• To increase tax revenue through changes in income tax thresholds

• To set minimum wage levels across the economy

A central bank raises interest rates. What is the most likely effect on household consumption?

• Consumption increases because households earn more from savings

• Consumption falls because borrowing becomes more expensive and saving becomes more attractive

• Consumption is unaffected as interest rates only influence businesses

• Consumption increases because real incomes automatically rise

When interest rates are lowered, which of the following is most likely to occur?

• Aggregate demand falls as consumers reduce spending

• Investment increases as the cost of borrowing for firms decreases

• The exchange rate rises sharply, boosting exports

• Government tax revenues automatically increase

A government instructs its central bank to increase the money supply significantly. What is the most likely consequence in the long run?

• Deflation, as the value of money increases

• Inflation, as there is more money chasing the same quantity of goods and services

• Lower unemployment due to permanent increases in real output

• A fall in aggregate demand as confidence is undermined

Which of the following best describes "contractionary monetary policy"?

• Increasing government spending to stimulate economic growth

• Raising interest rates and reducing the money supply to reduce inflationary pressure

• Cutting income tax to increase disposable income

• Lowering interest rates to encourage household and business borrowing

A country raises its interest rates relative to those of other countries. What is the most likely effect on its exchange rate?

• The exchange rate depreciates as foreign investors withdraw funds

• The exchange rate appreciates as foreign investors move funds into the country to earn higher returns

• The exchange rate remains unchanged as monetary policy does not affect capital flows

• The exchange rate falls due to increased import spending

If a country's exchange rate appreciates following a rise in interest rates, what is the likely impact on its exports?

• Exports become cheaper and more competitive internationally

• Exports become more expensive and less competitive internationally

• Exports increase because domestic producers receive a subsidy

• Export volumes are unaffected by changes in the exchange rate

Quantitative easing (QE) involves:

• Raising interest rates to reduce inflationary pressure in the economy

• A central bank creating new money electronically to purchase financial assets, thereby increasing the money supply

• The government increasing income tax rates to reduce consumer spending

• Reducing the national debt by selling government bonds to the public

Quantitative easing is most likely to be used when:

• Inflation is running above the target rate and needs to be reduced quickly

• Interest rates are already near zero and the economy still requires further stimulus

• The government wishes to reduce its budget deficit by cutting public borrowing

• The economy is growing rapidly and the central bank wants to slow aggregate demand

A central bank cuts interest rates to stimulate economic growth. Which of the following is a potential drawback of this policy?

• Unemployment may fall too quickly, causing a labour shortage

• It may trigger inflationary pressure if aggregate demand increases too rapidly

• Government tax revenues will automatically fall as incomes decrease

• The exchange rate will rise, making imports more expensive for consumers