ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -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-2: -The Discount Rate and Monetary Policy Conversely, a raised discount rate makes it more expensive for banks to borrow and thereby diminishes the money supply while retracting investment activity.

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: -Future cash flows are reduced by the discount rate, so the higher the discount rate the lower the present value of the future cash flows. A lower discount rate leads to a higher present value. As this implies, when the discount rate is higher, money in the future will be worth less than it is today.

Detailed explanation-5: -A lower discount rate encourages banks to borrow from the Fed since the cost of borrowing has decreased. As banks borrow more from the Fed, their level of reserves rises which will cause them to loan out more to their customers. This will increase the money supply.