Progressive Movement Practice Exam

How does the Federal Reserve System manage the economy?

1. Insuring bank accounts

2. Raising or lowering income taxes

3. Setting tariff rates

4. Regulating interest rates

The correct answer is: Regulating interest rates

The Federal Reserve System, often referred to as the Fed, is the central banking system of the United States and plays a crucial role in managing the economy primarily through the regulation of interest rates. By adjusting the federal funds rate—an interest rate at which banks lend to one another— the Fed influences overall economic activity. When the Fed lowers interest rates, borrowing becomes cheaper for businesses and consumers, which can stimulate investment and spending, thereby promoting economic growth. Conversely, when the Fed raises interest rates, borrowing costs increase, which can help cool down an overheating economy and control inflation. This ability to regulate interest rates allows the Federal Reserve to manage liquidity in the economy and keep inflation in check, thereby ensuring long-term economic stability. The other options involve functions that are not part of the Federal Reserve's primary responsibilities. Insuring bank accounts is handled by the Federal Deposit Insurance Corporation (FDIC). Raising or lowering income taxes is a function of the federal government through Congress, not the central bank. Setting tariff rates falls under the purview of trade policy and is typically managed by lawmakers and the executive branch, rather than the Fed.