Final answer:
Raising the discount rate results in reduced reserves and a smaller money supply due to commercial banks borrowing less from the Fed and calling in loans, which also leads to higher market interest rates.
Step-by-step explanation:
An increase in the discount rate will reduce reserves and the money supply if banks respond appropriately to the change in the rate. When the central bank raises the discount rate, commercial banks are discouraged from borrowing reserves from the Federal Reserve because it becomes more expensive to do so.
Instead, they may call in loans to replenish their reserves, leading to fewer loans being available in the economy. As a result, the money multiplier effect is diminished, and the overall money supply contracts, which typically leads to an increase in market interest rates.