Federal Funds Rate vs. Federal Discount Rate
The federal funds rate is the interest rate that banks charge other banks when lending money to them. One of the consequences of having a reserve limit is that sometimes banks, in trying to stay as close to that limit as possible, may go under it and thus need to borrow some money to boost their reserves. This rate is set by the Federal reserve.
The federal discount rate is the interest rate that the Fed charges banks when it lends the bank money. This amount is higher than the Federal Funds Rate so it’s used as a last resort for banks needing some cash to boost their reserves.
In an earlier article on how the Fed rate affects the stock market, I made an error of omission by mentioning only the federal discount rate and wanted to take the opportunity to clear that up.
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[...] Update: In addition to the discount rate, the Fed also sets the federal funds rate but it generally moves lockstep with the discount rate. For a discussion on the difference, please refer to this article on the differences between the discount rate and the Federal funds rate. [...]
If the federal funds rate is lower than the discount rate, why would any commercial bank borrow from the Fed and pay the discount rate instead of borrowing from another bank and pay the federal funds rate?