Question

• Suppose today’s headline is that private investment has decreased as a result of actions by the Federal Reserve. Which of the following choices is the most likely cause?
  1. Selling Treasury bonds to commercial banks
  2. Lowering the discount rate
  3. Decreasing the reserve ratio
  4. Eliminating a corporate tax credit on investment
  5. A stronger stock market increased investor optimism

Answer 1

Higher interest rates tend to reduce private investment in physical capital.

If Federal reserve Sells teasury bonds to commercial banks the excess reserves of banks Decreases so it becomes expensive for banks to borrow excess reserves overnight and decreases the money supply. It also Increases the cost of borrowing, that is , Interest rate .

There is an inverse relationship between interest rate and Investment.

Thus, Higher interest rates further Decreases the Private investigation.

Therefore,the correct answer is Option A.

Option B is incorrect because if Fed  lowers the discount rate,it increases excess reserves in commercial banks throughout the economy and expands the money supply and Increase in Money supply Decreases the interest rate which further encourages Investment.

Option C is incorrect because decreasing the reserve ratio lowers the amount of cash that banks are required to hold in reserves which allowing them to make more loans to consumers and businesses. It results in increasing money supply which caused interest rate to Decrease and encourages Investment.

Option D is incorrect because Eliminating a corporate tax credit on investment will make it cheaper to make investment which will encourage Investment.

Option E is incorrect because  Increase in investor optimism will encourage investors to invest more which will increase the Investments