Question

Explain what type of policy a central bank can implement to raise the interest rate

Answer 1

The central bank can raise the interest by the following policies:

1) Raising the reserve requirements: Banks need to keep a fixed portion of their total deposits as reserves with the central bank. When the central bank increases the reserve requirement, it reduces the amount of fund available with banks for lending. This increases the interest rate.

2) Open market operations: The central bank can sell various securities (like Treasury security) to banks to reduce the amount of money available for banks for lending. Such open market operations also increase the interest rate.

3) Increasing discount rates: Discount rates is the rate at which the central bank lends to other banks on a short-term basis to meet their reserve requirement. The central bank can increase the interest rate by increasing the discount rate.