Question

Why will the Discount Rate (DR) always exceed the Federal Funds Rate (FFR)? If it does not, what will happen?

Answer 1

Discount rate is the rate on which the federal bank lends the money to the bank while federal fund rate is the rate that is used when bank lends to each other. The banks have to keep certain reserves and when this reserve is less than the required reserve they can borrow the money either from other banks or from the central bank. Some banks have excess reserve and they can lend this money.

Generally Discount rate is higher because if this is lower than the Federal fund rate then all the banks will approach to the central bank for borrowing the money. Then this will create a situation where some banks will end up having excess reserves. This will create imbalance in the market.