If the Fed is concerned about inflation, it should
The correct answer and explanation is:
Correct answer:
If the Fed is concerned about inflation, it should raise interest rates.
Explanation (300 words):
When the Federal Reserve (the Fed) is concerned about inflation—meaning the general increase in prices of goods and services across the economy—it aims to slow down the rate of inflation to maintain price stability and protect purchasing power.
Inflation typically occurs when demand outpaces supply, causing prices to rise. To counteract this, the Fed uses monetary policy tools, primarily by raising interest rates. Higher interest rates increase the cost of borrowing for consumers and businesses. When loans for cars, homes, or business investments become more expensive, people tend to borrow and spend less. Reduced spending lowers overall demand in the economy.
By raising interest rates, the Fed makes saving more attractive (because banks offer better returns on deposits), which further reduces consumption and investment. This cooling of demand helps slow down inflation, as less demand puts downward pressure on prices.
Moreover, higher interest rates also tend to strengthen the national currency. A stronger currency makes imports cheaper, which can reduce the prices of imported goods and help lower inflation.
If the Fed did the opposite and lowered interest rates when inflation is high, it would stimulate more borrowing and spending, increasing demand and potentially worsening inflation.
In summary, the Fed raises interest rates to reduce excessive demand, cool off economic overheating, and bring inflation back to a healthier level. This is part of contractionary monetary policy, which is used to control inflation. The Fed continuously monitors economic indicators like the Consumer Price Index (CPI), unemployment rates, and GDP growth to decide how aggressively to adjust interest rates to keep inflation in check without causing a recession.