Discount Lending
Banks borrow other banks’ required reserves to meet their legal reserve requirements
The interest rate is called the discount rate
The discount rate is not adjusted for the business cycle
Discounts and advances are procyclical
Procyclical Discount Borrowing
Interest rates rise in booms and fall in recessions/depressions
Discount rate is not adjusted much, if at all, over the business cycle
Thus discounts and advances are a good deal to banks during booms,
And a bad deal during recessions.
Procyclical Discount Borrowing
Discount rate is low compared to market interest rates during booms
Makes excess reserves low
Increasing M
Opposite effect during recessions/depressions
Reserve Requirement
R = 5% ….
DEM =
20
R = 10%
DEM =
10
R = 20%
DEM = 5