The Federal Reserve and the Discount Rate

the most important advantage of discount policy is that the fed can use it to: This is a topic that many people are looking for. is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, would like to introduce to you The Federal Reserve and the Discount Rate . Following along are instructions in the video below:

“You ever wondered why interest rates. Change or who controls them this is alex noogies noogies and financial iq. Consulting and in this presentation. I will explain how the federal plays a role in controlling the interest rates and why it even matters.

The federal reserve or the fed is a part government part private institution that controls the monetary policy needed to maintain a stable financial system in the us what do i mean by stable well the fed wants to maximize employment ensure stable prices. So that they don t double or triple from one day to the next and moderate long term rates. So that they don t increase or decrease. Abruptly.

The fed uses three important tools to maintain the stability. They control the reserve requirements. The discount rate and the open market operations today. I will focus on how it uses the discount rate to stabilize the financial system.

To do this i m going to use an example so let s start by presenting the players..

We have the fed the banks and the people so the way the system works is that people deposit money in banks. And banks deposit. A percentage of that money known as the reserve requirement at the fed conversely. The fed will lend money to banks and banks will lend money to the people.

The interest rate that the federal reserve charges banks on these loans is called the discount rate. The discount rate plays a major role in most every interest rate. That you can think of from the rate of a home mortgage to the rate of credit cards to show an example of how it works. Let s say that the fed sets the discount rate at 10.

This means that all the banks are paying. 10 to borrow the money from the fed adding a margin or the profit that they want to make and lending. It out to the people at their respective rates. The banks can charge whatever they please above the 10.

But it s to their best interest to offer a rate that will keep them competive at the market..

It s the people s responsibility to seek the best deal out there so how do you feel about these rates kind of high right. If you re thinking about borrowing money to buy a new car. A house or a new high definition plasma tv. That just came out.

And you had to have you might think twice because at these rates borrowing makes things we want more expensive so in general high interest rates will make people shy away and not borrow. But when people don t borrow they don t spend money in the economy. And when money isn t being spent the economy comes to a halt in a capitalistic society. These are very bad news.

Because people don t spend money businesses will fail and be forced to close more people will become unemployed banks will stop lending and money will stop circulating altogether instead of there being growth in the economy. We begin heading toward a recession. So what does the fed do now well when something doesn t sell at a high price. What do we do we lower the price.

However in this case..

The fed will lower the discount rate and so the federal reserve will gradually lower the discount rate to let s say 2. Which in turn will lower the rates that the banks lend to the people lower interest rates will stimulate borrowing. Which of course will also stimulate spending now the people will gladly return. But what is the problem now not only did the people that had plans of borrowing money come back.

But also some that did not have plans to borrow money even people that cannot afford to borrow money are now borrowing and spending. Because of this now. There s a surplus of money circulating in the economy. What problem are we faced with now let me explain by using this example.

Let s say that we have two people that live on an island one of them has a water bottle and the other one has a dollar for this example. Say. Let s say that this dollar was all the money that existed on the island. If the person that has the dollar wanted to buy the water bottle from the other person.

What is the most they would pay one dollar right what if now the person had ten dollars instead of..

One what is the most that they would pay for the water. Bottle 1000. Exactly this simple example. Explains an economic principle called inflation this means that a price of a good can fluctuate based on the money supply or how much money exists in the economy in the beginning of the presentation.

I explained that maintaining stable prices in the economy is one of the goals of the federal reserve so going back to our example. What will the fed do now they will gradually increase the discount rate. But not back to the 10. We had before instead something more in between let s say.

6. This will again change the rate that the banks offer money to the people and scare away those that had no business in borrowing money this will now cut the flow of money into the economy in order to help prevent inflation so that s it you just learned how the federal reserve uses the discount rate as a tool to maintain stability in the economy. The truth is that there is no perfect discount rate feds job is to lower and increase the rate depending on what is needed in the economy at a moment in time. It s a continuous balancing act hopefully you enjoy the presentation once again this is alex nor gauging with financial iq consulting thank you for listening ” .


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In this video I will describe how the Federal Reserve uses the Discount Rate as a monetary policy tool to stabilize the economy.

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