This preview shows page 1. Sign up to view the full content.
Unformatted text preview: charges its member banks to borrow money. Why would a bank need to borrow? Whenever a bank has more commitments due than it has in cash available, it can use monies in its reserve account with the Fed. If in doing this the balance in a bank's reserve account drops below that required by the Fed, the bank must borrow to bring it into compliance. It's not surprising that some experts refer to the Fed as the “Bankers' Bank”!
5-6 Licensing School for Appraisal, CPA, Contractors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 5: GOVERNMENT PARTICIPATION & BACKED LOANS
How can the discount rate be used to control the economy? If it costs the banks more to borrow money, this cost will be passed along to the consumer in the form of higher interest rates, or if the rate is lowered, the consumer should get the benefit of lower interest rates. There is a good example of how the use of increasing the reserve requirements and an increase in the discount rate can affect the economy. In the fall of 1979, the economy was in runaway inflation. Inflation was at an annual rate of 13 to 14% and the Fed felt that it had to do something quickly. So it raised the discount rate a full 1 percent, thus causing the interest rate to shoot up and cut the amount of money available. The real estate industry saw the interest rate on single–family loans go to 13 to 13.5 percent, if you could find a lender with funds to loan. EFFECTS OF MONEY SUPPLY MANAGEMENT
These major tools of money supply management can be used by the Fed to cause either tight money or easy money. Tight money is the policy of the Fed that makes money expensive (high interest rates). This is usually a restrictive policy, with high discount rates and increased reserve requirements. Thus, the money supply is reduced and, usually, the demand remains about the same: business still needs money to operate and to buy raw materials for production; the demand for housing goes on, but usually at a reduced rate. With about the same nu...
View Full Document
- Spring '10