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A news story titled as “Monetary policy: State Bank cuts benchmark interest rate to 10%” has been published in The Express Tribune dated October 06, 2012. The story provides the information about the reduction of benchmark interest rate from 10.5% to 10% by State Bank of Pakistan. The complete news story can be studied at the following link:
Some experts are of the view that this decrease in interest rate will be very beneficial for the economy while others are opposing this new policy of State Bank of Pakistan.
Being a student of Money & Banking, you are required to discuss in your own words whether this decrease in discount rate will be helpful for the economy or not? Your opinion must be supported by logical reasoning.
1. Your discussion must be based on logical facts.
2. The GDB will remain open for 3 working days.
3. Do not copy or exchange your answer with other students. Two identical / copied comments will be marked Zero (0) and may damage your grade in the course.
4. Obnoxious or ignoble answer should be strictly avoided.
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Discount rate is the rate that banks pay to borrow from the Federal Reserve system. A lower rate makes borrowing easier, so banks are able to make loans to ordinary people and businesses. This stimulates the economy.
When the discount rate is high it makes borrowing harder for banks. They then don't give as many loans out to people. This slows down the economy. The Fed can choose whatever rate they think is best at the time.
(Note: There is such thing as an investment discount rate, but that's a completely different discussion. Check the second link.)
FRB: The Discount Rate
How to Build Up the Discount Rate - ValuAdder
Discount rates can identify two different types of financial activity. One common use of the term has to do with the amount of interest that private banks pay to the United States Federal Reserve System in return for loan financing. The second application of the term has to do with the charge that merchants pay in order to process credit card payments as part of doing business.
When it comes to a Federal Reserve Discount Rate, the discount rate process lets the banks and other financial institutions to receive loans from the Federal Reserve at rates that are considered to be very competitive. This extension of a discount rate has an impact in two different ways. The immediate effect is that it makes it possible for financial institutions to pass on a portion of the savings to their clients.
However, the extension of a discount rate through the Federal Reserve can have a far reaching impact on investors and the function of various investment markets. Bond markets tend to react to the change in the discount rate, since available rates of interest have a direct impact on the desirability of bond purchases. While the stock market is less vulnerable to a change in the direct rate, it is still possible for a change in rate to impact the performance of the stocks of various companies who trade on the exchange.
The discount rate is the interest rate that Federal Reserve Banks charge when commercial banks borrow reserves. In principle, a decrease in the discount rate encourages banks to borrow, which increases the amount of available reserves held by the banking system, which then induces an increase in the money supply and a decrease in interest rates. An increase in the discount rate works in the opposite direction, discouraging borrowing, reducing available reserves, decreasing the money supply, and increasing interest rates
Although the Fed, in principle, can use the discount rate to control the total quantity of money in circulation, in practice, the discount rate is used primarily as a signal for monetary policy actions undertaken through open market operations
In the early years of the Federal Reserve System, before the emergence of modern financial markets, the discount rate was the primary tool of monetary policy. At that time reserve lending subject to the discount rate was the most effective means available for the Fed to control the amount of bank reserves and thus the money supply.
In modern times, the discount rate is simply less effective in controlling the amount of reserves held by banks than open market operations. Banks borrow reserves from the Fed for reasons beyond the discount rate, meaning a higher or lower discount rate might have very little impact on reserves and the money supply.
The economy can be influenced easily by interest rates. When interest rates are high, people do not want to take loans out from the bank because it is not easy to pay the loans back, and the number of purchases of cars and homes goes down.
The effects of a lower interest rate on the economy are very favorable for the consumer. When interest rates are low, people are more likely to take loans out of the bank in order to pay for things like houses and cars. When the market for those things gets strong, price decreases and more people can purchases these things.
Tariq bhai thk solution kon sa hy??????????
which solution is best, so that we can change it in our own words..
I think the lower in the discount rate will be helpful for the economy i agree with the discussion of Tariq bhai
Yes commercial banks will offer loans at lower rates and people will borrow more.