ABSTRACT
This chapter starts with the case of an economy in which inflation is low to moderate and the banking system is in reasonably good shape. Not all economies enjoy low inflation rates and stable banking systems. Consider a country with a very simple government and banking system. The country’s government finds it very difficult to collect enough taxes to pay its operating expenses, so it runs a printing press to print paper money and uses this money to pay its employees and its bills. If this situation continued for long, hyperinflation—often defined as any annual inflation rate higher than 100 percent—would likely result. While the Fed mostly uses open market operations to expand the money supply, it also has other tools at its disposal. One monetary policy tool available to the Fed is the discount rate. This is the interest rate at which commercial banks can borrow funds from the Fed at what is called the Fed’s “discount window.”
