Question

Please answer the following questions:

1. Why is the decision made by committee an important principle of Central Banks design?

2. Which component of the Federal Reserve System establishes the discount rate and what will be effect of its increase?

Please Write 300 words for each question and write in PRINT!

Answer 1

Ans 1. Central banks decision is important because they decide on monetary policy that impacts employment, economic stability and controlled inflation. They do all this by managing interest rates, setting reserve requirement and acting as a lender of last resort to the banking sector. Other responsibilities include controlling the money supply, managing foreign exchange and gold reserves and government stock register. They raise rates to slow growth and lower inflation and lower rates to boost growth. In an economy when interests rate are zero central banks pumps money directly into the economy. This process is named as Quantitative easing. In this process, using money they printed, they buy bonds and increase the money in the financial system. This encourages financial institutions to lend more allowing businesses and consumers to spend more boosting the economy.

Ans 2 Discount rates are established by each reserve bank’s board of directors, subject to the review and determination of the Federal Reserve System‘s Board of Governors. There are three lending programs. They are primary credit, secondary credit and seasonal credit

Under primary credit loans are extended for a very short term usually overnight to depository institutions that have sound financial condition.

Depository institutions that are not eligible for primary credit may apply for secondary credit to meet short term liquidity to resolve severe financial challenges.

Seasonal credits are offered to banks that supports agricultural or seasonal resort communities. In this sector institutions have recurring financial needs due to fluctuations throughout the year.

High discount rate raises the interest rate of other loans in the economy since it represents the cost of borrowing money for commercial banks and other depository institutions.

Interest rates represent the cost of borrowing money. With lower discount rate borrowing money from Federal Reserve will be less expensive, as such banks will charge less interest on their loans. Lower interests rate create ripple effect on the economy and increases demand for loanable funds thereby encouraging more businesses, more production and more demand.