Which of the following actions can be expected to result in a decrease in stock and bond prices, all else equal?
I. The Federal Reserve announces a decrease in the discount rate.
II. Congress votes to decrease payments to Social Security recipients.
III. Congress votes to decrease taxes.
IV. The Federal Reserve announces that it will sell some of the Treasury securities it owns on the open market.
Explanation
Answer: B - Only Selections II and IV will result in a decrease in stock and bond prices, all else equal. If Congress votes to decrease payments to Social Security recipients or if the Federal Reserve announces that it will sell some of the Treasury securities it owns on the open market, a decrease in stock and bond prices can be expected. A vote by Congress to decrease payments to Social Security recipients results in a decrease in money supply in our economy. Since interest rates can be thought of as the “price” of money, a decrease in the money supply will result in higher interest rates, which results in lower prices in the stock and bond markets. Similarly, if the Federal Reserve sells some of the Treasury securities it owns on the open market, a decrease in the money supply results, leading to an increase in interest rates and a decrease in securities’ prices. When the Federal Reserve decreases the discount rate and when Congress decreases taxes, the money supply is increased. The interest rate-the price of money-subsequently decreases (all else equal), and prices of stocks and bonds increase as a result.
