Question : The discount rate is the interest rate at which:
Option 1: Commercial banks borrow from the central bank
Option 2: Commercial banks lend to the central bank
Option 3: The government borrows from the central bank
Option 4: The central bank lends to the government
Correct Answer:
Commercial banks borrow from the central bank
Solution : The correct answer is (a) commercial banks borrow from the central bank.
The central bank sets the discount rate, which represents the interest rate at which commercial banks can borrow funds directly from the central bank. The discount rate serves as a tool for the central bank to provide short-term liquidity to commercial banks or influence their borrowing behavior.
When commercial banks face liquidity shortages or need additional funds, they can borrow from the central bank's discount window. The discount window is the mechanism through which banks can access funds directly from the central bank. The discount rate charged by the central bank on these loans represents the cost of borrowing for the commercial banks.
It's worth noting that the discount rate is typically set higher than other short-term interest rates to encourage commercial banks to seek funds from other sources first, such as interbank lending or borrowing from the money market. The discount window is generally seen as a backstop for banks facing temporary liquidity challenges.
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