CFA Level I · CFA Level I Exam · Monetary Policy
A central bank wants to raise short-term market interest rates in an economy where banks hold ample excess reserves. Which action would most likely be the central bank's main tool for this purpose?
Raising the interest rate paid on reserves is the most likely tool. With ample excess reserves, banks will not lend at less than they earn from the central bank, so a higher administered rate lifts market rates. Bond purchases and lower reserve requirements would ease policy.
- ARaising the interest rate it pays on reservesCorrect
- BLowering the reserve requirement
- CBuying government bonds in the open market
Explanation
When reserves are abundant, banks will not lend below the rate the central bank pays on reserves, so raising that rate lifts short-term rates. Buying bonds and lowering reserve requirements both add liquidity and push rates down, the opposite of the goal.
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