Question

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If the Fed increases the discount rate, banks will face a higher cost of borrowing and will pass some of this cost onto customers in terms of higher interest rates. O it will be easier for banks to borrow the money needed to provide a higher volume of commercial loans. O it will then increase the required reserve ratio as well. O it will then decrease the required reserve ratio to offset any possible contractionary effect..

Answer 1

1. The correct answer is the first option. This is because the federal discount rate is the interest rate at which the Federal Reserve lends funds to other banks. Increasing the discount rate increases the cost of borrowing for banks. Higher cost of borrowing creates a shortage of funds. Thus banks tend to charge higher interest rates on loans given to customers.

Second option is incorrect because as explained above increasing discount rate makes it difficult for banks to borrow money from the fed.

Third option is incorrect because increasing required reserve ratio also has a similar impact as increasing discount rate. Required reserves are the minimum amount of funds that the banks are required to maintain with themselves so as to meet unexpected fund requirements. High reserve ratio decreases money supply.

Fourth option is incorrect because increasing discount rate is itself a contractionary policy (reducing money supply), so there's no point offsetting this effect by decreasing reserve ratio.

2. The correct answer is second option. This is because when the fed buys government bonds in the open market, it is basically paying the public money to buy these bonds. This transfer of money in the hands of the public increases the liquidity and the money supply in the economy. This process is called open market operation.

First option is incorrect because open market operation is an expansionary monetary policy (increasing money supply) and not a contractionary policy (decreasing money supply).

Third option is incorrect because money demand not affected by open market operation.

Fourth option is incorrect because open market operation does have an impact on the money supply. It can't remain unchanged.

3. The correct answer is second option. This is because higher interest rate on alternative investments induce people to hold less money in liquid form. Conversely, lower interest rates makes them to prefer holding liquid money rather than bonds.

First option is incorrect because money demand curve is downward sloping. The reason is explained in the last point.

Third option is incorrect because real disposable income is the income adjusted for tax and price changes. Hence it is not an appropriate measure of determining money demand.

Fourth option is incorrect because real disposable income is the income adjusted for tax and price changes. Hence it is not an appropriate measure of determining money demand

4. The correct answer is second option. This is because excess reserves are the reserves in addition to and over the required reserves. So banks are not forced to hold on to them. So they usually lend it out. However it is important to note that after the 2008 financial crisis the fed started giving interest on these reserves. So banks now have more incentive to hold on to these reserves.

The first option is incorrect because banks have no incentive to do so.

Third option is incorrect because if customers will withdraw then the funds available with Banks for lending will decrease.

Fourth option is incorrect because banks don't generally sell their reserves to other banks