Question

Why does the Fed give interest on reserves held by commercial banks. (Interest Rate on Reserves IOR)

What is the discount rate in a Federal Funds Market?

Answer 1

Federal reserve provides interest on the reserves held by the commercial banks in order to encourage them to keep proportion of their deposits as reserves. This helps as a cushion in case of a bank run or a bank panic in case consumers start speculating the banking system and, a large number of depositors started demanding their money. This proposal by the federal reserve helps the commercial banks in handling these situations and also ensures that depositors money is available at withdrawal

Discount rate is the interest rate at which commercial banks can borrow from the federal reserve. This is also an important macroeconomic tool by the federal reserve where it can influence the amount of excess reserves available at banks..