An increase in the discount rate, everything else held constant, will:

Question

BlackTom AI · Accepted Answer

Raising the discount rate makes borrowing from the Federal Reserve more costly for banks, so banks will borrow less at the discount window; less borrowing means bank reserves fall and, with currency held by the public unchanged, the monetary base falls as well.

1) Relevant knowledge points and concepts
- Discount rate: the interest rate the central bank charges banks for short-term loans at the discount window.  
- Bank reserves: deposits banks hold at the central bank plus vault cash. Discount loans directly increase reserves when made.  
- Monetary base (MB): MB = Currency held by the public (C) + Reserves (R).  
- “Everything else held constant” implies no offsetting open-market operations or other central bank actions.

2) Step-by-step reasoning
- Increase in discount rate → borrowing from discount window becomes more expensive.  
- Banks, facing higher cost, reduce the quantity of discount loans they take.  
- A reduction in discount loans means a direct decline in reserves because discount loans are added to reserves when made.

3) Intermediate/calculation steps (simple algebraic expression)
- MB = C + R.  
- Under the assumption C is unchanged (public’s currency holdings unaffected), ΔC = 0.  
- Discount loan reduction ⇒ ΔR < 0.  
- Therefore ΔMB = ΔC + ΔR = 0 + (negative) = negative → MB decreases.

4) Why the correct answer is correct
Because discount loans are a direct source of bank reserves, a higher discount rate discourages those loans; fewer discount loans reduce reserves and, since reserves are a component of the monetary base, the monetary base also falls when nothing else changes.

5) Why the other options are incorrect
- (a) increase reserves but not the monetary base: wrong because higher discount rate reduces, not increases, discount borrowing; reserves would not rise.  
- (c) increase reserves and the monetary base: opposite of the actual effect.  
- (d) not affect reserves or the monetary base: incorrect because discount lending directly influences reserves, so changing its price affects reserve levels.

6) Conclusion
Thus, an increase in the discount rate, everything else held constant, will decrease reserves and the monetary base — answer b.

An increase in the discount rate, everything else held constant, will:Single choice

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