ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The Fed can also alter the money supply by changing short-term interest rates. By lowering (or raising) the discount rate that banks pay on short-term loans from the Federal Reserve Bank, the Fed is able to effectively increase (or decrease) the liquidity of money.

Detailed explanation-2: -An increase in the discount rate makes it less profitable for banks to borrow from the Federal Reserve. As banks reduce their borrowing, the total reserves of the banking system are reduced and the quantity of money supplied by the banking system declines.

Detailed explanation-3: -The Federal Reserve can increase the money supply by lowering the discount rate. a. Lowering the discount rate gives depository institutions a greater incentive to borrow, thereby increasing their reserves and lending activity.

Detailed explanation-4: -Why does the Fed increase interest rates? In short, the Fed hopes its rate hikes will temper demand for consumer goods and services by making it more expensive to borrow money.