Question

1. Explain how a decrease in the discount rate affects credit availability and the money supply.

2.Which of the monetary tools available to the Federal Reserve is most often used? Why?

Answer 1

1) The discount rate is the rate that the federal reserve charges the banks for borrowing funds. A decrease in discount rate means that banks can borrow more money at lower rates of interest, if banks are able to borrow at lower rates from federal reserve then banks can provide loans to consumer at lower rates and the credit will increase as lower rates will attract more customer. It will increase the money supply in the system as banks increases the lending and borrowing activity.

2) The most frequent monetary policy tools used by the federal reserve is the open market operation and the major reason for using it is it is flexible in nature. Open market operation is buying and selling of government security and treasury bills by the federal reserve. When the federal reserve wants to increase the liquidity in the system or increase the money supply or if it wants to reduce the money supply into the system then it will either buy or sell securities in the market and either reduce or increase the money supply. It is most frequently used because it is flexible in nature.