How does discount rate affect money supply

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Develop and improve products. List of Partners vendors. Setting a high discount rate tends to have the effect of raising other interest rates in the economy since it represents the cost of borrowing money for most major commercial banks and other depository institutions. This could be considered a contractionary monetary policy. Exactly how much a high discount rate affects the economy as a whole depends on the relationship between the discount rate and the normal market rate of interest for loans to banks.

In part, interest rates represent the cost of borrowing money. When it is less expensive for banks to borrow money from the Federal Reserve, they can subsequently charge less interest on their own loans.

This has a ripple effect on the demand for loanable funds everywhere unless the market rate of interest is equally as high. Interest rates also coordinate savings in the economy.

When too few actors want to save money, banks entice them with higher interest rates. Between savings and loans, interest rates help coordinate economic activity between different actors and different points in time. Increasing the reserve requirement decreases excess reserves in the system, thereby decreasing loan activity. The discount rate is the interest rate at which depository institutions can borrow from Federal Reserve Banks.

The Federal Reserve can increase the money supply by lowering the discount rate. Lowering the discount rate gives depository institutions a greater incentive to borrow, thereby increasing their reserves and lending activity.

The Federal Reserve can decrease the money supply by increasing the discount rate. Board of Governors of the Federal Reserve System. Actively scan device characteristics for identification. Use precise geolocation data.

Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. By Kimberly Amadeo. Learn about our editorial policies. Reviewed by Thomas J. Article Reviewed October 28, Thomas J.

Brock is a CFA and CPA with more than 20 years of experience in various areas including investing, insurance portfolio management, finance and accounting, personal investment and financial planning advice, and development of educational materials about life insurance and annuities. Learn about our Financial Review Board. Key Takeaways The discount rate is the interest rate that banks are charged to borrow money from the Federal Reserve. The discount rate is part of a toolset the Federal Reserve uses to influence lending, inflation, spending, and the economy.

The discount rate is used to influence banks to lend more or less to businesses and consumers. A higher discount rate means it's more expensive for banks to borrow funds, so they have less cash to lend.

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