Final answer:
When the Fed raises the discount rate, commercial banks typically increase interest rates on loans because their borrowing costs go up.
Step-by-step explanation:
When the Federal Reserve increases the discount rate, commercial banks are likely to increase interest rates on loans. This is because the cost for banks to borrow money from the Fed becomes higher, and they tend to pass on this cost to consumers to maintain their profit margins. Consequently, with higher costs of borrowing, banks would also seek to call in loans to replace those more expensive reserves, thereby making fewer loans available. This results in an increase in market interest rates as the money supply tightens. Although in recent decades the impact of changing the discount rate has been less significant due to banks preferring to borrow from sources other than the discount window, the theoretical response to an increase in the discount rate suggests a rise in loan interest rates.