Question

before 2008, what was the incentive for banks with excess reserves to lend money overnight to banks short of required reserves? multiple choice question. to reduce the amount of excess reserves they had and thus avoid penalties to earn some interest to improve their reputation to adhere to federal law requiring them to lend to other banks when asked

Answer 1

Before 2008, banks with excess reserves lent money overnight to other banks to earn interest on those reserves. The federal funds rate dictated the interest earned, and such activity was part of the central bank's execution of monetary policy during periods of economic uncertainty.

Step-by-step explanation:

Before 2008, the incentive for banks with excess reserves to lend money overnight to banks short of required reserves was to earn some interest. Banks are legally required to maintain a minimum level of reserves, but there is no penalty for holding excess reserves. However, during periods of economic uncertainty, such as a recession, banks might be more hesitant to lend because of the increased risk that loan applicants will not be able to repay their loans. This was evident during financial crises, where the lender of last resort, usually a central bank like the Federal Reserve, would step in to provide short-term emergency loans to ensure the stability of the financial system.

The overnight loans between banks are carried out at the federal funds rate, which is the interest rate at which one bank lends funds to another bank overnight. By lending their excess reserves, banks could profit from the interest earned, which was better than leaving the funds unutilized. This practice of interbank lending is one aspect of how a central bank executes monetary policy.