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Assume that currently the discount rate is 3%, the federal fund rate 3% and the interest...

Assume that currently the discount rate is 3%, the federal fund rate 3% and the interest rate on reserves is 0.5%. Suppose the Federal Reserve wants to lower the federal funds rate. Which of the following policy tools is more effective, a change in discount rate or a change in the interest rate on reserves? Use a supply and demand for reserves diagram to explain your answer.

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Answer #1

Discout rate is the rate at which banks borrow from Fed and Dederal funds rate is the rate at which banks borrow from each other.

Lowering Federal funds rate is a expansionary monetary policy and used in recessions. Federal reserve should reduce discounts rate as banks will have option to borrow from fed and hence Federal funds rate will come down.

Reducing interest rate on reserves will make banks riase intereston loans to compensate.

Decreasing interest rates on reserves will lead to more interest on normal loans. Banks will lend less and supply for money will go down.

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