Question

Just need an explanation: Thank you, will upvote!

How could the Fed change the cost of money for banks?

Answer 1

Fed can change the cost of money for banks by changing discount rate. Discount rate is the rate of interest charged by Fed on the funds given as loans and advances to commercial banks. So when discount rate is increased cost of borrowing for commercial banks will go up, whereas when discount rate is reduced cost of borrowing for commercial banks reduces. Another way to influence the cost of money for banks is to change the federal funds rate. It is the rate at which commercial banks lend money to other commercial banks overnight. So if this rate is increased, it will increase the cost of borrowing one bank borrowing from other commercial banks increase and when the rate is reduced the cost of borrowing falls.