Which of the following will happen when the Federal Reserve lowers the interest rate paid on reserve balances?

Question

Multiple Choice
Nonbank firms will choose to lend less money to the Fed.
Nonbank firms will choose to lend more money to the Fed.
Banks will choose to leave more of their money at the Fed overnight.
Banks will choose to lend in the money market instead of holding reserves at the Fed.

Answer 1

When the Federal Reserve lowers the interest rate paid on reserve balances, banks have less incentive to hold their reserves at the Fed, as they are earning less interest. Consequently, they may choose to lend more of that money in the money market or use it for other investments.

Therefore, the correct answer is:

Banks will choose to lend in the money market instead of holding reserves at the Fed.