Series 65 Economic Concepts Practice Questions

Correct answer: B. crowding out

Crowding out occurs when government borrowing raises interest rates and reduces private-sector investment that would otherwise have occurred. It is a recognized limit on the effectiveness of deficit-financed fiscal stimulus.

• A. A liquidity trap is a condition in which lower interest rates fail to stimulate borrowing or spending; it does not describe government borrowing raising rates.
• B. Correct: government borrowing raising rates and displacing private investment is crowding out.
• C. Stagflation combines high inflation, weak growth, and high unemployment, not deficit-driven interest rate increases.
• D. The Fisher effect links nominal interest rates to expected inflation, not to government borrowing and investment.

Correct answer: C. Expansionary fiscal policy

Tax and government spending decisions are fiscal policy, enacted by the legislature/executive branch, not the central bank. Cutting taxes to stimulate the economy is expansionary fiscal policy; monetary policy and quantitative easing are central-bank tools involving interest rates and the money supply.

• A. Monetary policy is conducted by the Federal Reserve through money supply and interest rate tools, not by Congress passing tax legislation, so this label doesn't fit.
• B. Contractionary fiscal policy would raise taxes or cut spending to slow the economy — this is the opposite of what's described.
• C. Fiscal policy is tax and spending action by the legislature; cutting taxes to spur investment and growth is the textbook expansionary fiscal move.
• D. Quantitative easing is a central-bank tool involving large-scale asset purchases, not a congressional tax law change.

Correct answer: B. Lower interest rates and, over time, upward pressure on prices

An increase in the money supply increases the availability of loanable funds, which tends to push interest rates down in the short run. Over time, more money circulating relative to the same level of goods and services tends to raise the general price level (inflation), consistent with the quantity theory of money.

• A. Increasing the money supply is expansionary and generally pushes interest rates down, along with upward (not lower) inflationary pressure over time.
• B. Correct. An increase in the money supply typically lowers interest rates in the near term and creates upward pressure on prices (inflation) over time as more money chases the same goods and services.
• C. An increase in the money supply is expected to have real effects on rates and prices, not leave them unchanged.
• D. Increasing the money supply is inflationary over time, the opposite of causing immediate deflation.

Correct answer: A. Inversion can signal expectations of lower future short rates and economic weakness, but as a signal it does not fix the timing or certainty of recession in the next quarter.

An inverted curve can reflect expectations of lower future policy rates and has been associated with economic slowdowns, but it is a signal rather than a deterministic forecast of recession or its timing.

• A. Correct: inversion carries information about expected rates and growth without establishing certainty or timing of a recession.
• B. Inversion is more often linked to expected rate cuts and slower growth than to accelerating inflation, and it proves nothing about inflation.
• C. Longer-duration bonds have more interest-rate price risk, not less, and inversion does not remove that risk.
• D. Yield-curve shapes do reflect market expectations about future short rates and growth, so saying they carry little information is wrong.