Question

What would be most likely to happen if the discount rate were raised?

A. Depositors would make a run on a bank.
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B. Banks would make fewer loans.
C. Creditors would refuse to pay back loans.
D. Banks would stop opening savings accounts.

Answer 1

B. Banks would make fewer loans

Step-by-step explanation:

The discount rate is the interest rate that commercial banks pay to the Federal Reserve for loans received. Banks usually borrow to cater to their short-term cash-flow requirements. The discount rate is higher than the inter bank rate or the fed funds rate(the rate that banks charge each other for loans).

An increase in the discount rate causes the inter bank rate to rise (the Fed controls both rates). It means commercial banks are borrowing money from the Fed and each other at a higher interest rate. Consequently, commercial banks charge a higher interest rate for loans advanced to customers. An increase in interest rates at the banks discourages customers from borrowing.