7. How does setting the discount rate work as a policy tool for the Fed? What is the impact on the economy if the Fed raises the rate? What is the impact if the Fed lowers the discount rate? (Include in your answer how a higher or lower discount rate impacts the market for borrowed funds, and how it indirectly affects aggregate demand in the economy overall.) 8. Suppose that the current Federal Reserve discount rate is 1.0%. If the Fed were to raise it by .25%, it would bring the rate to 1.25%.

a) Illustrate graphically how this increase in the price for borrowing from the Fed would impact the demand for Federal Reserve funds. (your graph will be in general terms, and will not be able to predict specific values for quantity demanded. Your Y axis will be the discount rate, and the X axis will be quantity of borrowed funds.)

b) Illustrate graphically the impact of a higher discount rate on the overall economy, using a graph of Aggregate Demand. The money supply: