Question 10 Chapter 16 The discount rate and the federal funds rate
Explanation: Close Explanation
Banks can borrow funds from the Federal Reserve to mak
... [Show More] e more loans when their own reserves
approach the minimum amount allowed by the required reserve ratio. An increase in the discount rate
makes borrowing from the Federal Reserve more expensive for banks. Because banks know that
lending past the required reserve ratio will be more costly, they will be stingier with their lending, and
fewer loans will be made. Fewer loans made means less money is created.
A decrease in the discount rate has the opposite effect. Borrowing from the Federal Reserve becomes
less expensive, so banks borrow more reserves from the Federal Reserve, increasing the level of
reserves in the banking system. The injection of reserves allows banks to make more loans, creating
additional money and increasing the money supply.
10. The discount rate and the federal funds rate
The discount rate is the interest rate on loans that the Federal Reserve makes to banks. Banks occasionally
borrow from the Federal Reserve when they find themselves short on reserves. A lower discount rate
banks' incentives to borrow reserves from the Federal Reserve, thereby
quantity of reserves in the banking system and causing the money supply to .
the
Points: 0.67 / 1
The federal funds rate is the interest rate that banks charge one another for short-term (typically
overnight) loans. When the Federal Reserve uses open-market operations to sell government bonds, the
quantity of reserves in the banking system
, and the federal funds rate
, banks' demand for borrowed reserves
.
Points: 1 / 1
Explanation: Close Explanation
To reduce the federal funds rate, the Federal Reserve uses open-market operations to buy government
bonds from the public. The Federal Reserve's government bonds purchase injects reserves into the
banking system. With additional reserves, banks are no longer as close to their required reserve ratio,
so the demand from banks for borrowed reserves declines, pushing the federal funds rate downward.
Similarly, the Federal Reserve sells government bonds in order to raise the federal funds rate. The sale
of government bonds reduces the quantity of reserves in the banking system, causing banks' demand
for borrowed reserves to rise. The increase in demand for borrowed reserves causes the federal funds
decreases
rises increases
rate to rise. [Show Less]