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: -Even so, interest rate hikes are known as the central bank’s one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services. Economists won’t know until later if the Fed’s moves were successful or not.

Detailed explanation-3: -The Federal Reserve can decrease the money supply by increasing the discount rate. a. Increasing the discount rate gives depository institutions less incentive to borrow, thereby decreasing their reserves and lending activity.

Detailed explanation-4: -If the central bank raises the discount rate, then commercial banks will reduce their borrowing of reserves from the Fed, and instead borrow from the federal funds market, or for more serious needs, call in loans to replace those reserves.

Detailed explanation-5: -If the Fed lowers the discount rate, it encourages banks to lend more money (since they can increase their reserves at a lower cost). The result is more loans for businesses and consumers, meaning an increase in the money supply, which spurs economic activity but also leads to greater inflation.