Fed Funds Vs. Discount Rates

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Hi David,

Could you explain the relationship / differences between the Fed discount rate and the Fed Funds rate?

 

[David Harper CFA FRM]

I'm no Fed expert, but here is my best bookmark on this.

As I understand, the fed funds rate is the practical policy tool; the Fed targets this overnight rate between banks via open market operations (but only gets this short term rate indirectly by buying/selling bonds). Whereas the discount rate can be fixed: it is the rate the Fed charges directly to loan to banks. As Francisco says, "Asking for a direct loan usually means that the bank was not able to obtain liquidity any other way. For that reason banks that request discount window loans are subject to scrutiny by the central bank, and watched closely by other banks. And the interest rate charged for direct loans is higher than the federal funds rate. For those reasons, the discount window is used rarely and in small amounts."