Question

How does the Fed use its discount window to influence the market interest rate?

Answer 1

The Fed uses the discount window to control the money supply and implement the monetary policy in the economy. Discount rate is the rate at which the Fed charges on the loans it lends to the banks. If the Fed intends to increase in the money supply i.e. in a way that the banks lend more to the public it will reduce the discount rate. This will reduce the interest rate charged by financial institutions as they now have more cash by borrowing more from the Fed. Reserve is true in case when the Fed wants to reduce the money supply. Banks will have more to borrow at higher rates and hence cannot be in a position to lend more thereby increasing the interest rate.