Explain the difference between the discount rate and the federal funds rate. If the Fed wants to lower one of these rates, which one can the Fed change by issuing an order? Describe in detail how the Fed helps to lower the other rate

Answer 1

The federal funds rate is the interest rate that banks charge one another for borrowing funds, while the discount rate is the interest rate that the Fed charges banks that borrow funds from them. The discount rate is the rate that the Fed can change by issuing an order. The federal funds rate is determined in the federal funds market. The Fed changes the federal funds rate by changing the amount of reserves in the banking system. More specifically, if the Fed wants to lower the federal funds rate they will need to exert downward pressure on this rate in the federal funds market. They can do this by conducting an open market purchase. This purchase would inject more reserves into the banking system, thereby increasing the supply of reserves in the federal funds market. As in any other market, when the supply increases the "price" paid (in this case, the federal funds rate) to get that item would decline.