How does an increase in the discount rate affect banks' behavior toward borrowing from the Fed?

An increase in the discount rate typically discourages banks from borrowing from the Federal Reserve. The discount rate is the interest rate charged to commercial banks and other depository institutions for short-term loans from the Fed. When the Fed raises the discount rate, the cost of borrowing from the Fed increases. This higher cost makes it less attractive for banks to take out loans from the Fed, as they would be paying more in interest.

As a result, banks may seek alternative sources of funding, rely more on their deposits, or reduce their borrowing activities overall. This behavior reflects the banks' goal of maintaining profitability by minimizing costly loans. Consequently, higher discount rates can lead to tighter credit conditions in the economy, as banks become more cautious in their lending practices.

In summary, the increase in the discount rate leads to reduced borrowing by banks due to higher costs, which is why the correct answer is that it discourages banks from borrowing.