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 discount rate is the interest rate at which commercial banks can borrow funds directly from the central bank. It serves as a tool for the central bank to influence the liquidity and borrowing costs of commercial banks, thereby affecting the broader economy.
When commercial banks face a shortage of funds or need liquidity support, they can turn to the central bank for short-term loans at the discount rate. By adjusting the discount rate, the central bank can encourage or discourage banks from borrowing. Lowering the discount rate makes it more attractive for banks to borrow from the central bank, as it reduces their borrowing costs. This, in turn, increases the liquidity of the banking system and stimulates lending and economic activity. Conversely, raising the discount rate makes borrowing from the central bank more expensive and can act as a measure to reduce excessive borrowing and control inflationary pressures.
