Question

What is the Fed Fund Rate and the Discount Rate and how do they relate to monetary policy?

Answer 1

Fed Fund rate is one of the monetory policy ,other being discount rate,to govern the U.S economy. Fed Fund rate is the rate at which one bank lend their money from their reserves to the other bank on an overnight basis. Here ,lending reserves means extra money that they have can only be lent. According to law,some amount of total deposit need to be kept by bank as reserve which cannot be lent but the extra reserves other than this could be lent.

Federal Discount rate is the other tool of their monetory policy.It is the interest rate at which the Federal Reserve Bank give loams to commercial banks and other depository institutions using a lending facility called discount window : primary credit, secondary credit, and seasonal credit, each with its own interest rate.It is generally higher than Fed Fund rate.

If the discount rate is risen,banks will take less loan and hence the money supply in the market will reduce which will slow down the Economic growth. And,when discount rate is reduced,banks will take loans and thus the money supply in the market increases thereby increasing the Economic growth.

The Federal fund rate changes depending upon the money supply in the market(which is controlled by Federal Reserve Bank).If the money supply in the market is reduced it will force the banks to raise the interest rate and hence fed Fund rates rises.Low federal interest means bank can borrow more from other bank indicating the expansion of economy.