Question 13

Open-market purchase lowers nominal interest rate.

An open-market purchase by the central bank increases the money supply, which typically leads to a decrease in nominal interest rates. This action encourages borrowing and investment, stimulating economic activity.

A) cut income taxes

Cutting income taxes can increase consumers' disposable income and potentially boost spending, but it does not directly influence nominal interest rates. This option affects fiscal policy rather than monetary policy, making it an incorrect choice in this context.

B) deficit-financed spending

Deficit-financed spending refers to government spending that exceeds revenue, which can stimulate the economy. However, it does not directly lower nominal interest rates; rather, it can lead to higher interest rates due to increased borrowing needs, making this option incorrect.

C) open-market purchase

An open-market purchase involves the central bank buying government securities, which injects liquidity into the banking system. This increase in the money supply lowers nominal interest rates, making this the correct answer.

D) raise discount rate

Raising the discount rate makes borrowing more expensive for banks, which usually leads to higher nominal interest rates. This action constricts the money supply and discourages borrowing, thus rendering this option incorrect.

Conclusion

The open-market purchase distinctly lowers nominal interest rates by increasing the money supply, while all other options either have no direct effect or counteract the desired outcome. As such, option C is the correct answer, effectively demonstrating the impact of monetary policy on interest rates.