When there is an increase in the discount rate (when there are limited reserves), the following happens:
1. Nominal interest rates go up: This is true. When the discount rate increases, it becomes more expensive for banks to borrow from the central bank. As a result, banks raise the interest rates they charge on loans to consumers and businesses, leading to an increase in nominal interest rates.
2. The supply of money decreases: This is true. An increase in the discount rate discourages borrowing by making it more expensive for banks to obtain funds. Consequently, banks have less money to lend out, leading to a decrease in the supply of money in the economy.
3. The demand for money decreases: This is NOT correct. When the discount rate increases and nominal interest rates go up, it generally leads to an increase in the demand for money. People prefer to hold onto money rather than spend or invest it when interest rates are high because they can earn more by saving. Thus, the demand for money typically increases in this scenario.
In summary, when there is an increase in the discount rate, nominal interest rates go up, the supply of money decreases, but the demand for money usually increases rather than decreases.
