HISET Social Studies Practice

In what scenario would the Discount Rate be raised by the Federal Reserve?

1. To encourage more lending in the economy

2. To combat inflationary pressures

3. To lower borrowing costs for consumers

4. To facilitate international trade

The correct answer is: To combat inflationary pressures

The correct response is indeed related to the Federal Reserve raising the Discount Rate as a measure to combat inflationary pressures. When inflation rises, it indicates that the prices of goods and services are increasing more quickly than desired. To tackle this issue, the Federal Reserve may increase the Discount Rate, which is the interest rate at which commercial banks can borrow from the Federal Reserve. A higher Discount Rate makes it more expensive for banks to borrow money, which typically leads to higher interest rates for loans they offer to consumers and businesses. This discourages borrowing and spending, thereby helping to reduce inflation by cooling down demand in the economy. In contrast, encouraging more lending in the economy generally aligns with lowering the Discount Rate, as this would make borrowing cheaper and stimulate investment and consumption. Lowering borrowing costs for consumers is also achieved through reducing the Discount Rate, rather than raising it, since higher rates would lead to more expensive loans. Lastly, while the Discount Rate can indirectly impact international trade by influencing economic growth and exchange rates, this is not a direct reason for its increase—the primary goal in raising it is to control inflation.