Business Degree Certification Practice Test

What action can the Federal Reserve take to stimulate the United States economy?

1. Selling government bonds on the open market

2. Increasing the discount rate

3. Reducing the reserve requirement

4. Cutting taxes

The correct answer is: Reducing the reserve requirement

The action that can effectively stimulate the United States economy is reducing the reserve requirement. When the Federal Reserve decides to lower the reserve requirement, it reduces the percentage of deposits that banks must hold as reserves, allowing them to lend out a larger portion of their deposits. This increase in available lending creates more money in circulation, enhances consumer spending and investment, and thus stimulates economic activity. By enabling banks to lend more, the Federal Reserve facilitates greater access to credit for businesses and consumers. This can lead to increased capital investments by businesses and higher consumer spending, both of which fuel economic growth. It's a crucial tool used by the Federal Reserve to manage the money supply and encourage economic expansion during periods of economic downturn or sluggish growth. The other options involve actions that would typically be used to tighten the money supply or slow down an overheated economy, rather than stimulating it. For instance, selling government bonds can drain money from the economy, increasing interest rates and reducing liquidity. Increasing the discount rate would similarly discourage borrowing by making it more expensive for banks to borrow from the Fed, which can lead to decreased lending and investment. Cutting taxes, while potentially pro-growth, is a fiscal policy that requires legislative action rather than a direct monetary policy tool that the Federal Reserve can implement