The discount rate is the interest rate the Fed charges on loans of reserves to b

Question

The discount rate is the interest rate the Fed charges on loans of reserves to banks. The federal funds rate is the interest rate banks charge for overnight loans of reserves to other banks.

Which of the following statements about the discount rate and the federal funds rate are true? Check all that apply.

Usually, banks borrow from the federal funds market rather than the discount window.

If the federal funds rate is higher than the discount rate, banks may borrow from the discount window.

If the Fed wants to expand the money supply, it can raise the discount rate.

A higher discount rate discourages banks from borrowing reserves and making loans.

Explanation / Answer

Correct option:

(b) If the federal funds rate is higher than the discount rate, banks may borrow from the discount window.

Reason: since banks want to borrow money at as less rate as possible, if discount rate is less than fed funds rate, then it will always choose the discount window.

(d) A higher discount rate discourages banks from borrowing reserves and making loans.

Reason: A higher discount rate makes borrowing expensive, making it expensive for banks to borrow money from Fed, as a result of which loans made by the banks fall.

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