Question

28. What is the difference between federal funds rate and the discount rate. Be sure to define cach and how/why they are used. 29. Explain 2 things you learned from Mr. Karl Dakin's lecture on capital.

Answer 1

Discount rate - It is the rate at which bank borrows money from the Fed.

Federal Funds rate - The rate at which banks borrow money from one another.

Difference:

Discount rate is directly decided by the Fed and is based on the current state of economy while the other one is determind by market forces - demand and supply of funds available in the open market. The Fed sets the target Fed Funds rate and buys and sells treasury bills in order to indirectly affect the economy until the target rate is achieved.

Before open market operations (buying and selling of funds in open market), the discount rate is used primarily as a tool to for expansion and contraction of money supply.

Feds fund rate gives Fed more power and flexibility in its monetary policy than discount rate because Fed can essentially control how much in T-bills to purchase or sell, however Fed can not control how much banks borrow from Fed.