The discount rate is the rate of interest the Fed charges for loans it makes to banks. An increase in the discount or interest rates makes it more expensive for banks to borrow from the Fed. A discount rate decrease makes it less expensive for banks to borrow. This article is talking about how the Fed decreased the discount rate making it easier for banks to borrow, increasing the money supply. The decrease in the discount rate increases the money supply because it lowers the bank=s costs and allows it to borrow more money from the Fed. More reserves are in the system, so the money supply increases and the interest rate banks charge customers also decreases. Because the interest rate that banks charge their customers has just decreased this is going to cause an increase in Investments. Obviously, the lower the market interest rate, or the interest rate that banks charge customers, the more people are going to invest. So, in other words a decrease in the discount rate is going to cause an increase in the quantity of Investments. As explained in a previous article (refer to article #4), this increase in Investments is one of the determinants for a shift forward in the Aggregate demand curve. Aggregate demand consists of the sum of consumption, investment, government, and net exports. So it is pretty straightforward that an increase in investment will cause an increase in the Aggregate demand. A shift forward in Aggregate demand causes the real output (or GDP) of the economy to increase. The aggregate demand curve will continue to shift forward until reaches the full potential GDP. The full potential GDP is where the economy is running at its full potential. Trying to make the economy reach its full potential is the purpose for monetary policy and the reason the Fed decreases or increases the discount rate. Aggregate demand graph with monetary policy.The process of how the monetary policy of decreasing the discount rate eventually increas...
