Chartered Market Technician (CMT) Practice Exam

What does the Federal Reserve largely control?

1. Both money supply and long-term interest rates

2. Inflation rates only

3. Stock market prices

4. Short-term interest rates only

The correct answer is: Both money supply and long-term interest rates

The Federal Reserve primarily controls the money supply and short-term interest rates through its monetary policy tools, including open market operations, the discount rate, and reserve requirements. By adjusting the money supply, the Fed influences the availability of credit in the economy, which in turn impacts short-term interest rates. When the Fed raises or lowers the federal funds rate, it directly affects the interest rates that banks charge each other for overnight loans, which subsequently influences consumer and business borrowing costs. Long-term interest rates, while not directly controlled by the Fed, are influenced by its actions and expectations regarding the economy. By managing the money supply and signaling its monetary policy intentions, the Fed can impact long-term interest rates indirectly. However, it is important to note that an array of other factors, such as inflation expectations and economic growth projections, also play significant roles in determining long-term rates. This understanding highlights why the correct response includes both the money supply and long-term interest rates. The Federal Reserve's broader influence on the economy extends beyond immediate control to shape economic conditions, which may affect long-term rates as a consequence of its policy decisions.