10. (Mishkin 18.6) \"The federal funds rate can never be above the discount rate
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Question
10. (Mishkin 18.6) "The federal funds rate can never be above the discount rate." Is this statement true, false, or uncertain? Explain your answer. 11. (Mishkin 18.15) Compare the methods of controlling the money supply-open market operations, loans to financial institutions, and changes in reserve requirements-on the basis of the following criteria: flexibility, reversibility, effectiveness, and speed of implementation. 12. (Mishkin 18.21) Why is it that a decrease in the discount rate does not normally lead to an increase in borrowed reserves? Use the supply and demand analysis of the market for reserves to explainExplanation / Answer
A)The federal funds rate can, at most, be equal to the discount rate. It can never be above. The federal funds rate is the interest that banks charge other banks for overnight loans while the discount rate is the interest rate the Fed charges banks for loans. The market for reserves model indicates that once the fed funds rate reaches the interest rate on reserves, it would never go below this rate i.e. the current prevailing rate since banks could then earn a risk-free interest rate paid directly from the Fed, rather than loaning excess reserves in
the more risky fed funds market at an equivalent or lower rate. This should prevent the fed funds rate from ever falling below the interest rate paid on reserves. However, generally the fed funds rate can (and has) been below the interest rate paid on reserves. This is because nonbank financial institutions, which cannot earn interest on reserves, participate in the federal funds market and provide a significant amount of funding to the market.
B)The methods central banks use to control the quantity of money vary depending on the economic situation and power of the central bank.
1. Print more money
2. Set reserve requirement
3. Influence intrest rates
4. Engage in open market operations
5. Introduce a quantitative easing program
C)Setting a high discount rate tends to have the effect of raising other interest rates in the economy, since it represents the cost of borrowing money for most major commercial banks and other depository institutions.
interest rates represent the cost of borrowing money. When it is less expensive for banks to borrow money from the Federal Reserve, they can subsequently charge less interest on their own loans. This has a ripple or immediate effect on the demand for loanable funds everywhere, unless the market rate of interest is equally as high.
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