Suppose that, for every 1-percentage-point decline in the discount rate, commercial banks collectively borrow an additional $2 billion from Federal Reserve Banks. Also assume that the reserve ratio is 10 percent. If the Fed lowers the discount rate from 4.0 percent to
3)5 percent, bank reserves will
A) increase by $1 billion and the money supply will increase by $5 billion.
B) decline by $1 billion and the money supply will decline by $10 billion.
C) increase by $1 billion and the money supply will increase by $10 billion.
D) increase by $10 billion and the money supply will increase by $100 billion.

Question

Quizplus · Accepted Answer

The Fed lowering the discount rate encourages banks to borrow more, increasing reserves. With a 10% reserve ratio, each dollar of reserves supports $10 in the money supply, hence a $1 billion increase in reserves leads to a $10 billion increase in the money supply.

Suppose That, for Every 1-Percentage-Point Decline in the Discount Rate