Discount Rate Cut
The question
The economy of Marenza is operating below full employment. To ease credit conditions, the central bank of Marenza lowers the discount rate, the interest rate it charges commercial banks that borrow reserves directly from it. Show the short-run effect of this action on the money market, assuming all else is held constant. Show the effect on the Money Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Discount Rate Cut: the worked answer
On the Money Market graph, Money supply (MS) shifts right.
Why Money supply (MS) shifts right
The discount rate is the policy rate the central bank charges banks that borrow reserves from it, not the market rate shown on the graph. Lowering it makes borrowing reserves cheaper, so banks acquire more reserves and expand lending, and the money supply rises at every interest rate. Because the central bank controls the quantity of money, the vertical MS line shifts to the right. Money demand is unchanged because the price level and real income are unaffected in the short run.
What happens to the equilibrium
The equilibrium nominal interest rate falls as the quantity of money in the economy increases.
The mistake students make on this one
A large share of students move nothing at all and simply slide down the MD curve, treating the discount rate as if it were the interest rate on the vertical axis. The discount rate is an administered rate that is not plotted on this graph; the rate on the axis is the equilibrium market rate, and it falls only because MS shifted right first.
On exam day
Never equate a policy rate named in the stem with the rate on the y-axis: the tool shifts a curve, and the equilibrium rate you read off the graph is the result of that shift, never the cause.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Money supply (MS) shifts right and every other curve on the Money Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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