Macroeconomics

‭1.‬ ‭Discount‬ ‭Rate:‬ ‭The‬ ‭discount‬ ‭rate‬ ‭is‬ ‭the‬ ‭interest‬ ‭rate‬ ‭at‬ ‭which‬‭commercial‬‭banks‬‭can‬‭borrow‬‭funds‬‭directly‬‭from‬ ‭the‬‭central‬‭bank‬ ‭.‬‭Banks‬‭can‬‭borrow‬‭from‬‭the‬‭central‬‭bank‬ ‭for‬‭various‬‭reasons,‬‭such‬‭as‬‭to‬‭meet‬‭reserve‬‭requirements,‬ ‭address‬ ‭short-term‬ ‭liquidity‬ ‭needs,‬ ‭or‬ ‭take‬ ‭advantage‬ ‭of‬ ‭lending‬ ‭opportunities.‬ ‭When‬ ‭central‬ ‭banks‬ ‭lower‬ ‭the‬ ‭discount‬‭rate,‬‭it‬‭becomes‬‭cheaper‬‭for‬‭commercial‬‭banks‬ ‭to‬ ‭borrow‬ ‭money‬ ‭,‬ ‭encouraging‬ ‭them‬ ‭to‬ ‭lend‬ ‭more‬ ‭to‬ ‭businesses‬‭and‬‭individuals.‬ ‭This,‬‭in‬‭turn,‬‭increases‬‭money‬ ‭supply and stimulates economic activity‬ ‭.‬ ‭Conversely,‬ ‭when‬ ‭the‬ ‭discount‬ ‭rate‬ ‭is‬‭raised,‬‭borrowing‬ ‭becomes‬ ‭more‬ ‭expensive‬ ‭,‬ ‭which‬ ‭can‬ ‭help‬ ‭cool‬‭down‬‭an‬

‭overheating‬‭economy‬‭and‬‭control‬‭inflation‬‭by‬‭reducing‬‭money‬‭supply‬ ‭.‬‭However,‬‭the‬‭discount‬ ‭rate‬‭is‬ ‭not‬ ‭the‬‭primary‬‭tool‬‭used‬‭by‬‭central‬‭banks.‬‭Changes‬‭in‬‭this‬‭rate‬‭are‬‭often‬‭seen‬‭as‬‭signals‬ ‭rather than major policy tools.‬ ‭How the discount rate works:‬ ‭ ➔ ‬ ‭When‬‭a‬‭bank‬‭borrows‬‭funds‬‭from‬‭the‬‭central‬‭bank‬‭through‬‭the‬‭discount‬‭window‬‭at‬‭the‬‭discount‬ ‭rate, it increases its reserves.‬ ‭ ➔ ‬ ‭These‬ ‭reserves‬ ‭are‬ ‭essentially‬ ‭funds‬ ‭that‬ ‭the‬ ‭bank‬ ‭can‬ ‭use‬ ‭to‬ ‭make‬ ‭loans‬ ‭to‬ ‭individuals,‬ ‭businesses, or other borrowers.‬ ‭ ➔ ‬ ‭The‬ ‭central‬ ‭bank‬ ‭can‬ ‭influence‬ ‭the‬ ‭monetary‬ ‭base‬ ‭(MB)‬ ‭by‬ ‭adjusting‬ ‭the‬ ‭discount‬ ‭rate.‬ ‭Specifcally,‬‭if‬‭the‬‭central‬‭bank‬‭lowers‬‭the‬‭discount‬‭rate,‬‭it‬‭becomes‬‭cheaper‬‭for‬‭banks‬‭to‬‭borrow‬ ‭money from the central bank, which increases their reserves, and hence, the monetary base.‬ ‭ ➔ ‬ ‭An‬ ‭increase‬ ‭in‬‭the‬‭reserves‬‭of‬‭commercial‬‭banks‬‭through‬‭borrowing‬‭from‬‭the‬‭central‬‭bank‬ ‭can‬ ‭lead‬‭to‬‭an‬‭expansion‬‭of‬‭the‬‭money‬‭supply‬ ‭(Ms)‬‭in‬‭the‬‭broader‬‭economy.‬‭Banks‬‭can‬‭use‬‭these‬ ‭additional reserves to create more loans, which increases the amount of money in circulation.‬ ‭2.‬ ‭Overnight‬‭Interbank‬‭Lending‬‭Rate/Policy‬‭Rate/Federal‬‭Funds‬‭Rate:‬ ‭These‬‭are‬‭different‬‭names‬ ‭for‬ ‭the‬ ‭same‬ ‭rate.‬‭It‬‭is‬‭the‬‭Fed‬‭funds‬‭rate‬‭in‬‭the‬‭U.S.,‬‭the‬‭LIBOR‬‭in‬‭the‬‭UK,‬‭and‬‭the‬‭SHIBOR‬‭in‬ ‭China.‬ ‭This‬ ‭rate‬ ‭represents‬ ‭what‬ ‭commercial‬ ‭banks‬ ‭charge‬ ‭each‬ ‭other‬ ‭for‬ ‭short-term‬ ‭loans‬ ‭,‬ ‭typically‬‭spanning‬‭a‬‭single‬‭night.‬‭It's‬‭common‬‭for‬‭banks‬‭to‬‭engage‬‭in‬‭such‬‭lending‬‭transactions.‬ ‭For‬ ‭instance,‬‭when‬‭a‬‭bank's‬‭customers‬‭make‬‭unexpected‬‭withdrawals,‬‭causing‬‭the‬‭bank‬‭to‬‭fall‬ ‭below‬ ‭its‬ ‭required‬ ‭reserves,‬ ‭it‬ ‭may‬‭need‬‭to‬‭borrow‬‭from‬‭another‬‭bank‬‭with‬‭excess‬‭reserves‬‭to‬ ‭meet‬‭the‬‭requirement.‬‭Additionally,‬‭a‬‭bank‬‭may‬‭lack‬‭suffcient‬‭excess‬‭reserves‬‭to‬‭extend‬‭certain‬ ‭loans‬ ‭to‬ ‭its‬‭customers,‬‭in‬‭which‬‭case‬‭it‬‭can‬‭borrow‬‭funds‬‭from‬‭another‬‭bank‬‭and‬‭proceed‬‭with‬ ‭the loan.‬

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