Question from Level 1 Schweser Notes of Monetary and Fiscal Policy of Study Session 5: Economics:-
Contractionary monetary policy is least likely to decrease consumption spending by decreasing:-
a) expectations for economic growth
b) the foreign exchange value of the currency
c) securities prices
The correct answer given by schweser notes is option ‘b’. But wouldnt a decrease in securities prices cause an increase in demand for them? Increase in demand for lower priced securities will increase consumption spending. So shouldnt the answer be option ‘c’?
When we talk about “Spending” & “Demand”, we are refering to the purchase of goods and services. Securities are not a good nor a service. They are, indeed, capital investments, assets.
When securities prices decrease, there is commonly an increase in interest rate, so bonds and debt notes will increase in value. In the process of bond price increase, people has purchased bonds (they are not goods or services neither), so they are saving, hence decreasing their consumption.
Choice B is correct.
When the currency depreciates, imports become more expensive so consumption declines. However, contractionary monetary policy (higher interest rates) makes the domestic currency more attractive, and causes demand for that currency to go up resulting in appreciation. So, B is the current answer because tighter monetary policy leads to currency appreciation and thus is least likely to decrease consumption. Higher rates and weaker currency --> more saving, thus less demand for investments and buying securities. So lower securities prices can be a result of contractionary monetary policy, but isn’t a primary cause behind lower consumption.