An economy is experiencing a rate of inflation that is significantly above the central bank's target, whilst operating with a positive output gap. The central bank decides to engage in monetary tightening by selling government bonds directly to the financial sector (Quantitative Tightening). Which of the following describes the most likely transmission mechanism of this policy?
It will increase the price of government bonds, lowering long-term interest rates and encouraging business investment.
It will reduce the liquid reserves of commercial banks, leading to a contraction in credit creation and aggregate demand.
It will cause a depreciation of the domestic exchange rate, reducing the foreign-currency price of exports and boosting net exports.
It will increase the wealth of financial asset holders, thereby boosting consumption via a positive wealth effect.
176 exam-style questions on AQA A Level Economics 2.4 Financial markets and monetary policy (A-level only), covering 2.4.1 The structure of financial markets and financial assets, 2.4.2 Commercial banks and investment banks, 2.4.3 Central banks and monetary policy, and 2.4.4 The regulation of the financial system. Each one has a worked solution and a mark scheme showing where the marks go.