Question

If the interbank rate in an economy equals the interest rate on reserves, then an expansionary monetary policy will increase the interbank rate. True or False. Explain in your own words.

(Answers should be accurate, insightful, thorough, and clearly expressed. They should also demonstrate strong command of key ideas, theories, research findings, and policy debates)

Answer 1

This statement is False.

Reason: Expansionary monetary policy includes lower reserve requirement, lower discount rate and open market purchase. All these tools will increase the loan capacity of the banks. Also, with policy such as lower discount rate, the cost of borrowing will be lower if banks will now take their short term loan from central bank. With lower reserve requirement, commercial banks will now use their excess reserve to meet their loan requirements because the interest foregone by using reserves will same as the cost of borrowing from interbank loan. Therefore, all these factors will lower the interbank loan requirements and thus reduce the interbank interest rate.