When a bank repays a loan at the discount window to the Federal Reserve, which of the following will happen?

Question

BlackTom AI · Accepted Answer

Contextualizing the scenario helps: when a bank repays a loan at the discount window to the Federal Reserve, the transaction drains reserves from the banking system and reduces the monetary base.
Option 1: 'It will decrease bank reserves but have no effect on the monetary base.' This would imply reserves fall without impacting the monetary base, but the base is composed of reserves plus currency in circulation; a drain in reserves typically lowers the base as well, so this is inconsistent with how the base is defined.
Option 2: 'It will decrease bank reserves and immediately raise interest rates.' While reserves do fall, the act of repayment itself does not automatically raise interest rates in the immediate sense; rates are determined by supply-demand in the interbank market and policy stance, not directly by the bookkeeping effect of repayment. This makes the second option misleading.
Option 3: 'It will decrease bank reserves and decrease the monetary base.' This aligns with the standard accounting: when reserves are reduced due to repayment of a discount window loan, both bank reserves and the monetary base decline, since the base includes reserves.
Option 4: 'It will increase the monetary base by decreasing bank reserves.' This is the opposite of the actual relationship: decreasing reserves cannot increase the monetary base; it reduces it, not increases it. The wording here reverses the effect and is therefore incorrect.

BUSFIN 4265 SP2025 (5285) Quiz #2 Brandl 2e Chapters 7-10

When a bank repays a loan at the discount window to the Federal Reserve, which of the following will happen?

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