ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -If the federal funds rate, or the rate at which banks are willing to lend reserves to each other, equals the rate paid on excess reserves by the Fed, the commercial banks will be indifferent between the two options.

Detailed explanation-2: -A higher fed funds rate means more expensive borrowing costs, which can reduce demand among banks and other financial institutions to borrow money. The banks pass on higher borrowing costs by raising the rates they charge for consumer loans.

Detailed explanation-3: -If the federal funds rate is above the interest on reserve balances rate, then banks will seek to increase the return on their money by withdrawing funds from their reserve balance accounts at the Fed and lending these funds out in the federal funds market.

Detailed explanation-4: -Key Takeaways Conversely, by raising the banks’ reserve requirements, the Fed can decrease the size of the money supply. The Fed can also alter short-term interest rates by lowering (or raising) the discount rate that banks pay on short-term loans from the Fed.