📚 Learning Guide
Open Market Operations
easy

If open market operations are to interest rates as a thermostat is to room temperature, what is the role of the Central Bank in this analogy?

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Choose the Best Answer

A

It regulates the money supply to achieve desired interest rates.

B

It increases the amount of government bonds available.

C

It decreases the interest rates without affecting the money supply.

D

It eliminates the need for fiscal policy.

Understanding the Answer

Let's break down why this is correct

Answer

In this analogy, the Central Bank acts like the thermostat that controls the temperature in a room, which represents the economy. Just as a thermostat senses the room temperature and adjusts the heating or cooling to maintain a comfortable level, the Central Bank uses open market operations to influence interest rates. When the economy is too hot, meaning people are borrowing and spending too much, the Central Bank might sell government bonds to take money out of circulation, raising interest rates. Conversely, if the economy is too cold, with low spending and borrowing, the Central Bank can buy bonds to inject money into the economy, lowering interest rates. For example, if families are struggling to buy homes, the Central Bank might lower interest rates to make loans cheaper, encouraging more home purchases.

Detailed Explanation

The Central Bank controls the money supply. Other options are incorrect because This answer suggests that the Central Bank only focuses on government bonds; This option implies that lowering interest rates can happen without changing the money supply.

Key Concepts

Open Market Operations
Monetary Policy
Interest Rates
Topic

Open Market Operations

Difficulty

easy level question

Cognitive Level

understand

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