Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What are the functions of monetary policy?

1. Tax collection, spending, and savings

2. Interest rates, inflation control, and employment

3. Interest rates, money supply, and foreign trade

4. Interest rates, money supply, and inflation control

The correct answer is: Interest rates, money supply, and inflation control

Monetary policy primarily involves managing the economy's money supply and interest rates to achieve key objectives, which typically include controlling inflation, encouraging economic growth, and maintaining employment levels. The correct choice highlights three crucial components of monetary policy: interest rates, money supply, and inflation control. Interest rates are a vital tool used by central banks to influence economic activity. By adjusting the rates at which banks can borrow money, central banks can affect lending and spending behaviors across the economy. Lowering interest rates tends to stimulate borrowing and spending, which can promote economic growth. Conversely, raising interest rates is often employed to curb inflation by making borrowing more expensive and thereby slowing down economic activity. The money supply is another fundamental aspect of monetary policy. Central banks use various methods, such as open market operations and reserve requirements, to regulate the amount of money available in the economy. Controlling the money supply helps maintain price stability, as an increase in money supply without corresponding economic growth can lead to inflation. Inflation control is a primary goal of monetary policy, as excessive inflation can erode purchasing power and destabilize the economy. Through the manipulation of interest rates and the money supply, central banks aim to keep inflation within a target range, ensuring a more predictable economic environment.