A central bank provides emergency funding to a commercial bank that cannot meet its immediate obligations. The central bank is acting as

Issuer of the national currency.

Inflation has risen well above its target. The most likely monetary policy response is to

Raise Bank Rate and begin quantitative tightening.

Cut Bank Rate and begin quantitative easing.

Cut Bank Rate and raise government spending.

Raise Bank Rate and cut the rate of income tax.

A cut in Bank Rate raises consumption partly because households with variable-rate mortgages

See their monthly repayments fall.

Face higher monthly repayments.

Save more in response to lower returns.

Switch to fixed-rate mortgages.

A cut in Bank Rate is likely to raise net exports because it causes

Hot money to flow out, depreciating the pound.

Hot money to flow in, appreciating the pound.

The pound to appreciate, making exports cheaper.

The pound to depreciate, making exports dearer.

Quantitative easing increases the money supply because the central bank

Buys government bonds from banks and investors.

Cuts Bank Rate as far as it can towards zero.

Lends directly to households and firms.

Sells government bonds to commercial banks.

Quantitative easing is intended to raise aggregate demand by

Raising banks' liquidity so they lend more.

Increasing the government's tax revenue.

Raising the interest rate paid on savings.

Reducing the quantity of money in circulation.

A central bank cuts Bank Rate sharply during a deep recession, but consumption barely responds. The most likely explanation is that

Weak confidence leads households to save instead.

Firms have too much spare capacity to invest.

The exchange rate has appreciated.

2.4.3 Central Banks and Monetary Policy — Practice Questions

Nine original multiple-choice questions on central banks and monetary policy, written to the style and difficulty of AQA Paper 3 Section A.

9 questions AQA A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 2.4.3 Central Banks and Monetary Policy revision notes.

9 questions in this set

1. A central bank provides emergency funding to a commercial bank that cannot meet its immediate obligations. The central bank is acting as

Definition in context

Select one answer
A A prudential regulator.

B Issuer of the national currency.

C Lender of last resort.

D The government's own bank.
Show model answer
Answer: C (Lender of last resort.). Lender of last resort is the central bank's role in a liquidity crisis: it lends to a solvent bank that cannot raise cash quickly enough elsewhere, so that a temporary shortage does not turn into a collapse and spread to other banks.

Why the other options are wrong
- A — Prudential regulation is setting capital and liquidity rules and stress-testing banks in advance. It is preventative, not an emergency loan.
- B — Issuing currency is a separate function, giving the central bank sole authority over notes and coins.
- D — Acting as the government's bank means holding its accounts and managing its borrowing, not rescuing commercial banks.
2. Inflation has risen well above its target. The most likely monetary policy response is to

Applied reasoning

Select one answer
A Cut Bank Rate and begin quantitative easing.

B Cut Bank Rate and raise government spending.

C Raise Bank Rate and begin quantitative tightening.

D Raise Bank Rate and cut the rate of income tax.
Show model answer
Answer: C (Raise Bank Rate and begin quantitative tightening.). Bringing inflation down means reducing aggregate demand, which calls for contractionary monetary policy: a higher Bank Rate to raise the cost of borrowing and the reward for saving, and quantitative tightening to reduce the money supply.
Both tools push the same way, which is what makes the pairing coherent.

Why the other options are wrong
- A — This is expansionary policy — it would raise aggregate demand and push inflation higher still.
- B — Cutting Bank Rate is expansionary, and government spending is a fiscal instrument, not a monetary one.
- D — Raising Bank Rate is right, but cutting income tax is fiscal policy and it pulls in the opposite direction by raising disposable income.
3. A cut in Bank Rate raises consumption partly because households with variable-rate mortgages

Applied reasoning

Select one answer
A Face higher monthly repayments.

B Save more in response to lower returns.

C See their monthly repayments fall.

D Switch to fixed-rate mortgages.
Show model answer
Answer: C (See their monthly repayments fall.). A variable-rate mortgage reprices when Bank Rate moves, so a cut feeds through to lower monthly payments almost at once. That leaves households with more disposable income to spend on everything else, which raises consumption.
This channel sits alongside the two more familiar ones: cheaper borrowing and a smaller reward for saving.

Why the other options are wrong
- A — Repayments fall when Bank Rate falls. Rising repayments would follow a rate rise.
- B — Lower returns on saving are a reason to save less and spend more, which reinforces the effect rather than working against it.
- D — Some households may remortgage, but that is a response to the rate change, not the reason consumption rises.
4. A cut in Bank Rate is likely to raise net exports because it causes

Applied reasoning

Select one answer
A Hot money to flow in, appreciating the pound.

B Hot money to flow out, depreciating the pound.

C The pound to appreciate, making exports cheaper.

D The pound to depreciate, making exports dearer.
Show model answer
Answer: B (Hot money to flow out, depreciating the pound.). Lower UK interest rates make sterling deposits less attractive, so foreign investors move hot money abroad in search of better returns. Selling pounds raises the supply of sterling on the foreign exchange market, so the pound depreciates.
A weaker pound makes UK exports cheaper abroad and imports dearer at home, so net exports rise. This is the exchange rate channel of the transmission mechanism.

Why the other options are wrong
- A — Hot money chases the higher return. A rate cut pushes it out, not in.
- C — This contains a contradiction: an appreciation makes exports dearer abroad, not cheaper.
- D — The same contradiction the other way round: a depreciation makes exports cheaper, which is precisely why net exports improve.
5. Quantitative easing increases the money supply because the central bank

Definition in context

Select one answer
A Buys government bonds from banks and investors.

B Cuts Bank Rate as far as it can towards zero.

C Lends directly to households and firms.

D Sells government bonds to commercial banks.
Show model answer
Answer: A (Buys government bonds from banks and investors.). Under quantitative easing the central bank creates new money, digitally, and uses it to buy government bonds from banks and other financial institutions. The sellers end up holding cash instead of bonds, so the money supply rises and the banking system becomes more liquid.

Why the other options are wrong
- B — Cutting Bank Rate is the conventional tool, and it is a separate instrument. QE is normally used precisely when rates are already near zero and cannot fall further.
- C — Central banks do not lend to households and firms directly. QE works through the financial institutions that hold the bonds.
- D — Selling bonds takes money out of the system. That is quantitative tightening, the opposite policy.
6. Quantitative easing is intended to raise aggregate demand by

Applied reasoning

Select one answer
A Increasing the government's tax revenue.

B Raising banks' liquidity so they lend more.

C Raising the interest rate paid on savings.

D Reducing the quantity of money in circulation.
Show model answer
Answer: B (Raising banks' liquidity so they lend more.). Buying bonds leaves commercial banks holding more cash and fewer securities. With greater liquidity and a profit motive, banks want to lend more, and to attract borrowers they lower the interest rates they charge.
From there the effect is much the same as a cut in Bank Rate: cheaper credit raises consumption and investment, so aggregate demand rises.

Why the other options are wrong
- A — QE is a monetary operation by the central bank. It does not raise tax revenue, which is a fiscal matter.
- C — QE pushes interest rates down, including the return on savings. Higher savings rates would discourage spending.
- D — QE increases the quantity of money. Reducing it is quantitative tightening, which lowers aggregate demand.
7. Interest rates are already close to zero, and further cuts are having almost no effect on consumption and investment. This situation is best described as

Definition in context

Select one answer
A A credit crunch.

B A liquidity trap.

C Moral hazard.

D Quantitative tightening.
Show model answer
Answer: B (A liquidity trap.). A liquidity trap is where interest rates are so close to their lower bound that further cuts cannot do useful work: there is almost no room left to cut, and households and firms hold money rather than spending it whatever the rate.
Conventional monetary policy loses traction, which is why central banks turned to quantitative easing after 2008.

Why the other options are wrong
- A — A credit crunch is a sharp contraction in the availability of loans, usually because banks are rebuilding liquidity. Here the problem is that cheap credit is not being taken up.
- C — Moral hazard is excessive risk-taking by banks that expect to be rescued. It concerns bank behaviour, not the effectiveness of rate cuts.
- D — Quantitative tightening is a deliberate contractionary policy. Nothing here is being tightened.

8. Table 1 shows one economist's four predictions for the effects of a cut in Bank Rate.
Using Table 1, the prediction most likely to be wrong is

Data interpretation

Table 1: Predicted effects of a cut in Bank Rate
Prediction	Variable	Predicted effect
1	Consumption	Rises
2	Investment	Rises
3	The pound	Appreciates
4	Inflation	Rises

Select one answer

A Prediction 1.

B Prediction 2.

C Prediction 3.

D Prediction 4.

Show model answer

Answer: C (Prediction 3.). Three of the four follow the transmission mechanism correctly. Cheaper borrowing raises consumption and investment, and the resulting rise in aggregate demand puts upward pressure on inflation.
Prediction 3 has the exchange rate backwards. Lower UK rates make sterling less attractive, so hot money flows out, the supply of pounds rises and the pound depreciates — it does not appreciate.

Why the other options are wrong

A — Consumption does rise: borrowing is cheaper, saving less rewarding, and variable-rate mortgage payments fall.
B — Investment does rise, because a lower cost of borrowing makes more capital projects worth undertaking.
D — Inflation would be expected to rise, since the whole point of the policy is to raise aggregate demand.

9. A central bank cuts Bank Rate sharply during a deep recession, but consumption barely responds. The most likely explanation is that

Applied reasoning

Select one answer
A Firms have too much spare capacity to invest.

B The exchange rate has appreciated.

C The money supply has fallen.

D Weak confidence leads households to save instead.
Show model answer
Answer: D (Weak confidence leads households to save instead.). The transmission mechanism assumes households and firms respond to cheaper credit — but that response depends on confidence. In a deep recession people fear for their jobs and future income, so they pay down debt or build up savings rather than spending, however cheap borrowing becomes.
Two related limits reinforce this: much of any rate cut passes through slowly because many borrowers are on fixed-rate deals, and near the zero lower bound there is little room to cut at all.

Why the other options are wrong
- A — Spare capacity is a reason firms may not invest, which is plausible in itself. But the stem asks specifically about household consumption.
- B — An appreciation would reduce net exports, not consumption — and a rate cut would tend to cause a depreciation in any case.
- C — A cut in Bank Rate is expansionary and would be expected to support the money supply through more lending, not reduce it.

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Revision Notes: Central Banks and Monetary Policy AQA Past Papers Book a Free Intro Call

1. A central bank provides emergency funding to a commercial bank that cannot meet its immediate obligations. The central bank is acting as

2. Inflation has risen well above its target. The most likely monetary policy response is to

3. A cut in Bank Rate raises consumption partly because households with variable-rate mortgages

4. A cut in Bank Rate is likely to raise net exports because it causes

5. Quantitative easing increases the money supply because the central bank

6. Quantitative easing is intended to raise aggregate demand by

7. Interest rates are already close to zero, and further cuts are having almost no effect on consumption and investment. This situation is best described as

8. Table 1 shows one economist's four predictions for the effects of a cut in Bank Rate.Using Table 1, the prediction most likely to be wrong is

9. A central bank cuts Bank Rate sharply during a deep recession, but consumption barely responds. The most likely explanation is that

Your score

8. Table 1 shows one economist's four predictions for the effects of a cut in Bank Rate.
Using Table 1, the prediction most likely to be wrong is