Question

Please explain why

QUESTION

1. A discount loan by the Fed to a bank causes a(n) ________ in reserves in the banking system and a(n) ________ in the monetary base.

   	A.	increase; decrease
   	B.	decrease; decrease
   	C.	decrease; increase
   	D.	increase; increase

Answer 1

A discount loan is usually takes place when the central bank purchases collateral from banks in the open market operations at the central bank rate. The securities are purchased at a discount to its fair value. The discount compensates for the haircut(risk that the collateral may lose value during the term of the loan) & central bank rate(Fed funds rate)

This purchase of securities through open market operations adds liquidity into the financial system by decreasing reserves held by each bank with the central bank.

This decrease in reserves leads to greater amount of money in circulation also known as the monetary base since banks can know use this money to lend to end consumers such has retail & commercial customers.

A discount loan by the Fed to a bank causes a(n) decrease in reserves in the banking system and a(n) increase in the monetary base.