Loading the player...

What is the 'Federal Discount Rate'

The federal discount rate is the interest rate set by the Federal Reserve on loans offered to eligible commercial banks or other depository institutions as a measure to reduce liquidity problems and the pressures of reserve requirements. The discount rate allows the federal reserve to control the supply of money and is used to assure stability in the financial markets.

BREAKING DOWN 'Federal Discount Rate'

Depository institutions and commercials banks that are in generally sound financial condition are eligible to borrow from their regional Federal Reserve banks at a primary credit, or discount, rate. These loans are normally extended on an overnight basis for the purpose of banks meeting short-term liquidity needs. Funds for commercial banks borrowed from the Fed to improve their money supply are processed through the discount window, and the rate is reviewed every 14 days. The federal discount rate is one of the most important indicators in the economy, as all other interest rates move up and down with it.

Federal Reserve Monetary Tools

The federal discount rate is used as a tool to either stimulate (expansionary monetary policy) or rein in (contractionary monetary policy) the economy. A decrease in the discount rate makes it cheaper for commercial banks to borrow money, which results in an increase in available credit and lending activity throughout the economy. Conversely, a raised discount rate makes it more expensive for banks to borrow and thereby diminishes the money supply while retracting investment activity.

Besides setting the discount rate, the Federal Reserve can influence money supply, credit and interest rates through open market operations in U.S. Treasury markets, and by raising or lowering reserve requirements for private banks. The reserve requirement is the portion of a bank's deposits that it must hold in cash form, either within its own vaults or on deposit at its regional Reserve bank. The higher reserve requirements are, the less room banks have to leverage their liabilities, or deposits. Higher reserve requirements are more typical during a recession when a central bank wants to ensure banking panics and runs don't cause financial failures. The Federal Reserve acts upon its dual mandate to maximize employment and reduce inflation.

The discount rate is determined by the Federal Reserve's Board of Governors, as opposed to the federal funds rate which is set by the Federal Open Markets Committee (FOMC). The FOMC achieves the fed funds rate through the open sale and purchase of U.S. Treasuries, whereas the discount rate is reached solely through review by the Board of Governors.

RELATED TERMS
  1. Adjustment Credit

    A short-term loan made by a Federal Reserve Bank to a smaller ...
  2. Federal Reserve Credit

    Refers to the process of the Federal Reserve lending funds on ...
  3. Reserve Ratio

    The portion (expressed as a percent) of depositors' balances ...
  4. Reservable Deposit

    A bank deposit subject to reserve requirements. Reserve requirements ...
  5. Federal Funds

    Excess reserves that commercial banks deposit at regional Federal ...
  6. Federal Open Market Committee - ...

    The branch of the Federal Reserve Board that determines the direction ...
Related Articles
  1. Personal Finance

    Explaining the Federal Discount Rate

    The federal discount rate is the rate at which eligible banks or other depository institutions can borrow funds from a Federal Reserve bank.
  2. Trading

    How The Federal Reserve Manages Money Supply

    The Fed's three main tools are manipulating reserve requirements, changing the discount rate, and open-market operations.
  3. Trading

    Understanding the Federal Open Market Committee

    The Federal Open Market Committee is the branch of the Federal Reserve Board that determines monetary policy.
  4. Insights

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  5. Trading

    Explaining the Federal Reserve System

    The Federal Reserve System is the central bank of the United States. It regulates monetary policy and supervises the nation’s banking system.
  6. Trading

    How Do Central Banks Inject Money Into The Economy?

    Central banks inject money into the banking system, and remove money from it, through monetary policy actions.
  7. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  8. Insights

    Understanding How the Federal Reserve Creates Money

    Read about how the Federal Reserve actually targets and creates new money in the economy, and find out why the savings and loans system magnifies this process.
  9. Insights

    Understanding the Bank Rate

    Bank rate is a term describing the interest rate a country’s central bank charges its domestic banks on loans it makes to them.
  10. Insights

    What's the 1913 Federal Reserve Act?

    The 1913 Federal Reserve Act was a pivotal congressional act that helped establish the Federal Reserve System as it exists today. It is one of the United States financial system’s most influential ...
RELATED FAQS
  1. How does the Federal Reserve determine the discount rate?

    Learn about the several different kind of discount rates offered to banks and other depository institutions through the Federal ... Read Answer >>
  2. Why do commercial banks borrow from the Federal Reserve?

    Learn how commercial banks borrow from the Federal Reserve to meet minimum reserve requirements, and discover the pros and ... Read Answer >>
  3. What are the implications of a high Federal Funds Rate?

    Learn the implications of a high federal funds rate, which include constriction of the money supply, a stronger dollar and ... Read Answer >>
  4. Why would the Federal Reserve change the reserve ratio?

    Understand the Federal Reserve's monetary policy and the tools it uses to change that monetary policy. Learn about the reserve ... Read Answer >>
  5. How is money supply used in monetary policy?

    Learn about the three components of the Federal Reserve's monetary policy. Understand how these three components use the ... Read Answer >>
  6. What impact does the Federal Reserve have on a bank's profitability?

    Learn how the Federal Reserve impacts a bank's profitability with its influence on the discount rate, federal funds rate ... Read Answer >>
Hot Definitions
  1. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  2. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  3. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  4. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  5. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center