how the short interst rate affect the policy of central bank? with example

Expert Solution

The central bank affects the short-term interest rates with the monetary policy with the goal of attaining low inflation and sustainable growth in the economy. Discount rate refers to the rate of interest that the Central Banks charge commercial banks for short-term loans. Lowering the discount rate will be expansionary as it has influence on other rates of interest. The lower rates will encourage spending and lending by businesses and consumers. In a similar approach, an increase in the discount rate will be contractionary because the rate of discount has influence on the other interest rates. The higher rates will discourage spending and lending by businesses and consumers.
When FOMC want to create a higher incentive for banks to lend their excess reserves, it can reduce the rate of interest it pays on excess reserves. Consequently the banks tend to lend money instead to hold it in reserve thus resulting to an expansionary policy. In a similar approach, if FOMC want to reduce the bank's incentive to hold more excess reserves, it reduce the lending by increasing the interest rate paid on reserves, and leading to a contractionary policy

Rahul Sunny answered 8 months ago

how the short term interset rate affect the central bank and the economy?

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