ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -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. 3.

Detailed explanation-2: -A decline in the discount rate leads to a decline in the interest rate for taking a loan, lowering the cost of taking loans. Hence, commercial banks can take loans from the Fed at a lower cost. This is usually done to increase the amount of money supply within the economy.

Detailed explanation-3: -The Fed can increase the money supply by lowering the reserve requirements for banks, which allows them to lend more money. Conversely, by raising the banks’ reserve requirements, the Fed can decrease the size of the money supply.

Detailed explanation-4: -So the first thing that happens with an increase in the money supply is that interest rates fall. As interest rates fall, businesses are more willing to invest to borrow for investment spending. And consumers, too, are more willing to borrow to buy cars and homes and so on. Thus spending increases.

Detailed explanation-5: -When the discount rate is raised, it becomes more expensive for commercial banks to borrow money from the Fed. They borrow less of it and also increase the interest rates charged to their customers. Thus, the money supply in the economy reduces when the discount rate is raised.