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Any Econ wizes around to help with foolish econ 101 question? *updated question*

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DeviousTrap

Diamond Member
Trying to help a friend with what should be a quick econ question and it's bothering me how quickly I forgot all this.

Suppose that the Central Bank in Little Spot – known as The Little Big – wants to offset the effect of reduced profit expectations on government bond rates and bank loan rates. What should Little Big do?
a. Little Big should engage in expansionary open market operation by selling bonds.
b. Little Big should engage in expansionary open market operation by buying bonds.
c. Little Big should engage in contractionary open market operation by sellings bonds.
d. Little Big should engage in expansionary fiscal policy by cutting taxes and increasing pspending.
e. Little Big should not do anything because all central bank actions are inflationary.
Click to expand...

Now, I want to say D. A and E are both wrong. But B and C are mixing me up.

First of all, doesn't B have the same exact effect as D? Both are expansionary so won't either one result in rising bond prices and falling interest rates? And aren't those two always inversely proportional? How does that fix a problem where there is reduced profit on both interest rates and bonds? I have to be missing something ridiculously simple...

Turns out that the correct answer is C, so now I'm thoroughly confused. Anyone have some more insight on this?
 
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DeviousTrap said:
Trying to help a friend with what should be a quick econ question and it's bothering me how quickly I forgot all this.



Now, I want to say D. A and E are both wrong. But B and C are mixing me up.

First of all, doesn't B have the same exact effect as D? Both are expansionary so won't either one result in rising bond prices and falling interest rates? And aren't those two always inversely proportional? How does that fix a problem where there is reduced profit on both interest rates and bonds? I have to be missing something ridiculously simple...
Click to expand...

I vote b.

d is wrong because central banks don't control fiscal policy - that's what politicians do.
 
f. Little Big should buy MBS and screw themselves with toxic assets. Ask Big Brother for a bailout but use bailout money to buy more toxic assets.
 
b - buy up bonds and throw money out there - expansionary monetary policy
CB wouldn't set the fiscal policy ...err what JS80 said 😉

edit: i guess i didn't read the question.. i just went with whatever choice seem to be correct.. A didn't make sense and B did..
Referring to the actual question... the CB would want to increase interest rates to offset the lower expectation of the govt bonds so it would contract by buying up the money supply (selling bonds)
 
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her209 said:
f. Little Big should buy MBS and screw themselves with toxic assets. Ask Big Brother for a bailout but use bailout money to buy more toxic assets.
Click to expand...

In this story Little Big is Big Brother, but thanks for attempting to interject uninformed and irrelevant P&N-isms into the thread.
 
DeviousTrap said:
Trying to help a friend with what should be a quick econ question and it's bothering me how quickly I forgot all this.



Now, I want to say D. A and E are both wrong. But B and C are mixing me up.

First of all, doesn't B have the same exact effect as D? Both are expansionary so won't either one result in rising bond prices and falling interest rates? And aren't those two always inversely proportional? How does that fix a problem where there is reduced profit on both interest rates and bonds? I have to be missing something ridiculously simple...
Click to expand...

Central banks don't control fiscal policy. They control monetary policy. Also, selling bonds makes government debt cheaper, which wouldn't not offset lower government returns.
 
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Just remember that bond rates are generally inverse to "open market" interest rates. If ir is expected down, buy bonds.
 
Answers were published today, but without any explanations. It turns out that the correct answer is C, so now I'm thoroughly confused. Anyone have any more insight?
 
DeviousTrap said:
Answers were published today, but without any explanations. It turns out that the correct answer is C, so now I'm thoroughly confused. Anyone have any more insight?
Click to expand...

It's a poorly worded question IMO.

offset the effect of reduced profit expectations on government bond rates and bank loan rates
Click to expand...

Are they trying to increase member banks' profit expectations or increase the Central Bank's profit expectation? If the answer is C then the question is asking how do you increase the Central Bank's profit. They would sell bonds to raise target interest rates, which is what they charge the member banks, and would increase the central bank's interest income but lower member bank's profits.
 
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