Other things constant, if the Fed decreased the discount rate,
A) the earnings of the Fed would increase.
B) the incentive of commercial banks to borrow from the Fed would be reduced.
C) the prime interest rate would automatically decline.
D) commercial banks probably would reduce their excess reserves and be more willing to extend additional loans.

Question

Quizplus · Accepted Answer

When the Fed decreases the discount rate, it becomes cheaper for commercial banks to borrow from the Fed. This reduces their incentive to hold excess reserves and encourages them to extend additional loans, which in turn stimulates economic activity. Therefore, option D is the best choice. Option A is incorrect because the earnings of the Fed depend on many factors and cannot be predicted simply by a change in the discount rate. Option B is incorrect because a lower discount rate makes borrowing more attractive, not less. Option C is incorrect because the prime rate is determined by market forces and is not directly influenced by the Fed's discount rate.

Other Things Constant, If the Fed Decreased the Discount Rate