Discount Rate

The Federal Reserve makes available a Short-Term Credit Facility to member banks via the Discount Window. The Interest Rate offered on the facility is the Discount Rate and is an instrument of Monetary Policy.

There are two main avenues for U.S Banks to obtain a Credit Facility for their short-term financing needs. First, via the Interbank Market, so between the U.S. Commercial banks. This is the more common method for banks to cover short term financing needs. Second, the Federal Reserve Bank could offer a short-term credit line via the Discount Window. The Credit Facility is made available to cover any near-term liquidity issues due to a shortfall in cash. Or to prevent the possible failure of a Bank. The Interest Rate charged on the Short-Term lending facility available to member banks via the Federal Reserve is known as the Discount Rate. This is one of the methods by which the Federal Reserve manages Monetary Policy in the U.S.

The Federal Reserve sets the Discount Rate by raising or lowering the Rate. When the Discount Rate is reduced the objective is to increase Money Supply by reducing the cost of borrowing, to stimulate lending. An Accommodative Monetary Policy, or Dovish the opposite is Hawkish. The end goal is to stimulate economic activity to avoid a possible recession. In 2007 and 2008 the Discount Window was widely used as the financial condition of some U.S. Banks deteriorated sharply. To stimulate the economy, the Federal Reserve injected liquidity into the financial system. One way was by lowering the Discount Rate. The Fed Funds rate, is another Interest Rate under the Federal Reserve, which is a Rate suggested by the FOMC.