What recommendations can you provide to your senior manager on loan rates, depending on the Federal Reserve System's ratio percentage? What should the bank do when the Fed raises the discount rate and the Federal Funds Rate? What should the bank do when the Fed increases and decreases the reserve ratio to change the reserve requirement?
Answer - The bank must increase interest rate on loans if fed follows contractionary policy and raises the discount and federal funds rate. This is because the bank will not be able to borrow less at high rates and hence lesser lending is possible. So the rates must be increases.
If the fed raises the reserve requirement , banks will have lesser funds to lend , hence interest rates of banks must be increased. If the reserve ratio is increased , as a part of expansionary policy , the interest rates by banks should be decreased.
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