The discount rate is the most important indicator that forms the main aspects of the activities of credit institutions. So, it represents the interest rate set by the national bank of the country for other commercial banks. Its size depends on the monetary policy pursued by the state and the goals it pursues.
For example, at high inflation rates, the discount rate rises. The consequence of this is the rise in price of loans issued by the national bank. Accordingly, borrowed funds of commercial banks are becoming much more expensive, the demand for the provision of credit services is decreasing. In such a simple way, the government helps to reduce the money supply, and then the withdrawal of part of the cash from circulation. This helps stop inflationary growth and keep it at a certain boundary.
The discount rate is a tool of the central bank, with the help of which it regulates the main processes of the economy, for example, maintains the national currency at the required level, controls the amount of money in circulation, and forms the country's foreign exchange reserve. In practice, a sharp increase or decrease in the interest rate is rarely observed , as a rule, insignificant but no less effective adjustments are allowed.
When the discount rate rises, the national currency stabilizes. In addition, commercial banks lack credit resources, because central bank loans are becoming an expensive pleasure. It was at this time that the discount rate of bank interest on deposit operations increased. Under the proposed conditions, it is more profitable for the population to transfer existing capital to a deposit account than to invest in production or financial activities. Thus, there is a withdrawal of funds from circulation for a certain period, which means a decrease in inflation. This method is used when pursuing a policy called “expensive” money.
A policy of "cheap" money implies a reduced refinancing rate. It is introduced when there is a decline in production activity in the country. The government understands the need to maintain a certain industry and creates such conditions for credit organizations that allow lowering interest rates on loans and borrowings, especially for legal entities. This is how capital flows into industry or into the sphere of specific services, and industry development is stimulated.
It is worth noting that the above measures are considered effective, but are valid only in a certain period of time. Further increase or decrease in the rate leads to negative consequences. Unfortunately, each event has some drawbacks. The regulation of the refinancing rate also has a “reverse side of the coin,” which is as follows:
- The increased discount rate provokes a decrease in wages, business leaders are forced to reduce the number of jobs. All this naturally increases the burden on labor exchanges and creates tension in society.
- Lowering the rate, of course, gradually takes the country out of crisis, as it contributes to the development of the industrial sector. In addition, the state, therefore, supports small and medium-sized enterprises, allowing them to stay afloat even in the most difficult situations. But only for a while, then rapid inflationary growth is observed, which threatens the entire economy of the country.
We can conclude that the discount rate is a good tool that serves to achieve the main objectives of the monetary policy of the state, but it should be managed competently.