Discount Rate vs Federal Funds Rate
Discount Rate and Federal Funds Rate are two Money & Monetary Policy concepts in AP Economics that students often mix up. In short: discount rate is the interest rate the Federal Reserve charges commercial banks for short-term loans. Meanwhile, federal funds rate is the interest rate at which banks lend their excess reserves to other banks overnight. Here is how they compare side by side.
The interest rate the Federal Reserve charges commercial banks for short-term loans.
When the Fed lowers the discount rate, it becomes cheaper for banks to borrow, encouraging more lending and increasing the money supply. Raising the discount rate has the opposite effect, tightening monetary policy. It is one of the Fed's tools to influence economic activity.
The interest rate at which banks lend their excess reserves to other banks overnight.
The Federal Open Market Committee sets a target for this rate to influence borrowing costs across the economy. Changes in the federal funds rate affect consumer and business loans, investment, and overall economic growth. It is the primary tool the Fed uses to implement monetary policy.
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