Question

Which of the following Fed actions will increase bank lending?

Select one or moreanswers from the choices shown.

a. The Fed raises the discount rate from 5 percent to 6 percent.

b. The Fed raises the reserve ratio from 10 percent to 11 percent.

c. The Fed lowers the discount rate from 4 percent to 2 percent.

d. The Fed sells bonds to commercial banks.

Short answer

The correct option, in this case, will be c). The Fed lowers the discount rate from 4 percent to 2 percent.

Step-by-step solution

Step 1. Explanation for the correct option

When the discount rates are reduced, the commercial banks are encouraged to borrow more funds from the Fed. Commercial banks use these excess reserves for lending purposes, thereby increasing bank lending.

Step 2. Reasons for the incorrect options

a. This is incorrect because if the discount rates, that is, the rate at which the Fed grants loans to commercial banks, increase, it will reduce the lending.

b. This is incorrect because when the reserve ratio increases, the reserves decrease, and so does lending.

d. This is incorrect because when the Fed sells bonds to commercial banks, it absorbs reserves from them, and lending is reduced.