Evaluating the Pending Fed Changes - Essay Example

Central banks to increase or decrease the money supply can increase or decrease the reserve requirement. By reducing the reserve requirement, the central bank increases the loanable funds in the economy thus increasing the money supply to create growth through monetary expansion. The higher money supply will put pressure on the interest to go down as an increase in the money supply causes the equilibrium rate of interest to fall thus providing a sort of easy money for individuals to borrow however on the same hand increased money supply can increase inflation in the economy too.

Similarly, an increase in reserve requirements will have the opposite impact on the economy.

Economic Impact of Changes in Discount Rates

Changes in discount rates are considered one of the high-sensitivity measures taken by the Central Bank to alter the money supply in the economy. Assuming other things constant, a change in the discount rates like an increase in discount rates will increase the interest rates in the economy. With the increase in interest rates, firms and individuals will find it hard to borrow money at cheaper rates. Once interest rates go up the demand for money decreases internally however from the external business environment perspective, the demand for money will increase because foreign investors will it lucrative to invest in the economy because it is offering higher interest rates, especially on short-term investments. The immediate economic impact of the change in the discount rate will be an increase in the interest rates. This increase in interest rates will increase the borrowing costs of the firms hence their profitability and revenue. This reduction in revenue and profitability will in return decrease the GDP of the economy.

Options for Bank

2 actions are being anticipated by the Bank that FED will be taking. One is the increase in the reserve requirements and then there are also rumors of a 2% increase in discount rates. In this scenario, the only viable option for the bank will be to sell its long-term investments. Since interest rates are going to rise therefore the market price of these investments will decrease it will be better if we sell these investments now and convert them into cash so that we can place them on high-interest rates. The most important advantage of this action would be that the Bank will be able to save depreciation in its investment due to an increase in interest rates in the future however a disadvantage would be that the Bank will be losing some of its strategically placed investments.