Question

To reduce inflation, the Federal Reserve _____ the money supply. This action also causes the economy to shrink.

Answer 1

The answer is (a.) increases

When there is an inflation which is a sustained increase in the level of prices for the goods and services in the economy, the Fed (Federal Reserve or Federal Reserve System) which it the central banking system will increase the money supply. When the interest rate increases, the money will go rare and causes the economy to shrink.

Answer 2

The answer is B. The federal government decreases the money supply.

Different methods used by the central bank to increase or reduce the amount of money in the banking system are known as the monetary policy. The Fed reserve’s monetary policy is one of the methods in which the American government tries to control or regulate the economy of the nation by controlling the money supply. With an increasing inflation, the monetary policy needs to balance economic growth.

It can influence the money supply by modifying the banks’ reserve requirements. By raising the reserve requirements, banks are able to loan more and the Fed reserve is able to decrease the size of the money supply. A decrease in supply means that people and firms will hold and as a result will spend less.