018 Home Grade Personalized Reviews Discussion Course Materials The Monetary Sys
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Question
018 Home Grade Personalized Reviews Discussion Course Materials The Monetary System Graded Assignment nt | Read Chapter 16 | Back to Assignment Due Sunday 07.01.18 at 11:45 F Attempts: Average: /2 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 thereby banks' incentives to borrow reserves from the Federal Reserve, the quantity of reserves in the banking system and causing the money supply to 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 systemY other ,banks' need to borrow from each and the federal funds rate Y Copyright Notices Terms of UsePrivacy Notice Security Notice Accessibility
Explanation / Answer
Solution:
Discount rate:
Since, discount rate is the rate at which banks take loans from the Federal Reserve bank, lowering it decreases the cost of borrowing for the banks. As a result, this increases the banks' incentives to borrow resereves from the Federal reserve bank. Since, now more reserves will be borrowed by all banks, it automatically increases the quantity of reserves in the banking system. With required reserve ratio (minimum fraction of checkable deposits or minimum fraction of total reserves required to be kept as reserves) same as before, the excess reserves, and thus the loaning funds increase. Also, when discount rate is lowered, bank also lowers it's lending rate, incentivising people to borrow more. Both these factors together, cause the money supply to rise.
Federal funds rate:
When the Federal reserve bank sells government bonds' in open market operations, on buying these bonds, the money goes from banks to the Federal reserve, and so the quantity of reserves decreases in the banking system. Now, there is left less of it to lend to public as, now banks have lower (excess) reserves from which they lend, so their need to borrow from each other increases. Due to high demand of borrowing (from each other), the cost of borrowing also goes up, i.e, federal funds rate rise.
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