The Federal Reserve and its tools

Grade 12 Social Studies Worksheet

Circle the best answer.

1. Read this first

   Federal funds rate, inflation and unemployment, December 2021 to 2024

   December of	Effective federal funds rate (percent)	PCE price index (2017 = 100)	PCE inflation over the year (percent)	Unemployment rate (percent)
   2021	0.08	112.09	6.0	3.9
   2022	4.10	118.37	5.6	3.5
   2023	5.33	121.76	2.9	3.8
   2024	4.48	124.98	2.6	4.1

   Note: Effective federal funds rate (FEDFUNDS, monthly average), PCE price index (PCEPI, index 2017 = 100) and civilian unemployment rate (UNRATE, from the BLS), all through FRED, retrieved Nov 14, 2026. Inflation is the percent change in the December index from the December before; the index for December 2020 was 105.70. Card B: The Fed's goals are maximum employment and stable prices, which it defines as 2 percent PCE inflation over the longer run. Card C: The real interest rate is the nominal rate minus inflation (a simple rule in our words). Card D: Economists disagree about how fast and how much interest-rate changes work through spending, jobs and prices, and supply problems also move prices.

2. 1.

   Pia applies card C to December 2022. Which statement about the cost of borrowing is best supported?

   • The real rate was about +9.7 percent, because inflation is added to the nominal rate
   • The real rate was 4.10 percent, because the nominal rate shows what borrowers truly pay
   • The real rate was about -5.9, which is the 2021 figure, since the sign shows borrowing was cheap
   • The nominal rate (4.10) was above 2021's but below inflation (5.6), so the real rate was about -1.5
3. 2.

   A commentator says the 2022 and 2023 rate rises brought inflation down from 5.6 to 2.9. Jun tests the claim with card D. What is the best verdict?

   • Refuted: inflation in December 2023 was still above 2 percent, so the rate rises failed
   • Plausible but not shown: inflation fell as the rate rose, yet supply problems also move prices
   • Refuted: the real rate was negative in 2022, so rates did nothing in 2022 or 2023
   • Shown: inflation fell in the same two years the rate rose, so the rate rises caused the fall
4. 3.

   A writer says the Fed's rate rises raised unemployment from 3.5 percent in December 2022 to 4.1 in December 2024. Kira tests it. What is the best reading?

   • Not shown: unemployment rose 0.6 points, but the table cannot show the rate caused it
   • Refuted: the rate fell from 5.33 to 4.48 in 2024, so higher unemployment came from cuts
   • Refuted: unemployment of 4.1 is below 2021's 3.9, so it did not rise
   • Shown: the rate rose in 2022 and 2023 and unemployment rose after it, so the rate caused it
5. 4.

   Economists dispute how fast rate rises slow spending (card D). Luz asks which added evidence would test the claim that rate rises slowed spending?

   • More months of the federal funds rate, to see exactly when each rise took place
   • PCE inflation for other countries, to see whether prices rose abroad in the same years
   • Spending data from the months after each rise, compared with spending before it
   • The unemployment rate for the same dates, since jobs move in step with spending

6. Note

   Brant is a made-up town. Card A: In the market for loans, the interest rate is the price of borrowing and the quantity is the dollars lent per year. Before any change, the rate was 5 percent and banks lent $100 million. Card B: A Fed rate rise reduces the money banks supply to lend at each interest rate (supply falls). Card C: A business boom makes firms want to borrow more at each rate (demand rises). Card D: A different move, a Fed rate cut, raises the money banks supply to lend at each rate. Card E (in our words): Open market operations are the Fed's purchases and sales of Treasury securities. When the Fed buys, it pays by adding to banks' reserve balances at the Fed; when it sells, those balances fall. More reserves tend to lower short-term interest rates; fewer tend to raise them. Card F (Federal Reserve Board): Reserve requirement ratios were reduced to 0 percent, effective March 26, 2020. Card G (in our words): The Fed's two goals are maximum employment and stable prices. Higher interest rates reduce borrowing and spending; lower rates raise them.

7. 5.

   Milo applies cards B and C to Brant's loan market. Which prediction is certain?

   • Lending falls, because the Fed's rate rise cuts the money banks have to lend at each rate
   • The rate rises and lending falls, since higher rates cut borrowing in this market as in others
   • The interest rate rises; lending can rise, fall or stay the same, depending on the sizes
   • Lending rises, because the boom makes firms want more loans at each interest rate on offer
8. 6.

   Later data show the boom's increase in demand is larger than the Fed's cut in supply. What happens to the rate and to lending, Noah asks?

   • The rate rises and lending falls below $100 million, since the Fed's move decides the outcome
   • The rate falls and lending rises, because banks compete to lend to the booming firms
   • The rate and lending both rise, since the gain in demand outweighs the fall in supply
   • The rate stays at 5 percent, because the two shifts offset each other in the price
9. 7.

   The Fed cuts its rate (card D) while the boom continues (card C). Ren predicts the loan market. Which prediction is certain?

   • The rate falls, because the Fed's cut raises the money banks have to lend
   • Lending rises; the rate may rise, fall or stay at 5 percent, depending on the sizes
   • The rate rises and lending falls, since a booming economy raises borrowing costs
   • Neither can be told, since one shift pushes the rate up and the other pushes it down
10. 8.

    Tala compares two Fed actions using card E. Which action adds reserves to the banking system, and what is it meant to do?

    • Buying securities adds reserves, which tends to lower short-term rates and support spending
    • Raising the IORB adds reserves, since banks earn more interest on the money they keep
    • Selling securities adds reserves, which tends to lower short-term rates and support spending in the economy
    • Buying securities takes reserves out, which tends to raise short-term rates and slow spending down
11. 9.

    Since March 2020, reserve requirements have been 0 percent (card F). Zee asks what that implies. Which statement is best supported?

    • Banks can lend without limit, because with no requirement nothing limits loans
    • A required ratio no longer limits how much banks can lend; the Fed's rate tools do the steering
    • The Fed lost its ability to affect lending, because the requirement was its main tool
    • Banks must now hold exactly zero reserves, since the requirement fell to 0 percent
12. 10.

    Unemployment is rising while inflation is above 2 percent. Ari asks why the Fed's two goals in card G pull apart. Which reason fits?

    • A rate rise cools prices but can cost jobs, while a cut helps jobs but can fuel prices
    • A rate cut fights inflation and a rate rise helps jobs, which is why the goals conflict
    • The goals conflict whenever rates change, so the Fed cannot pursue both goals at once
    • The goals do not conflict, because lower inflation brings lower unemployment too