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What Are the Factors That Would Influence the Federal Reserve in Adjusting the Discount Rate?

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What are the factors that would influence the Federal Reserve in adjusting the discount rate?

The discount rate is the INTEREST RATE where a financial institute may borrow money

directly from a Federal Reserve Bank. A few factors that influence the Fed to adjust

discount rate are: low employment levels, frail economy, elevated price fluctuations, low

economy production capacity and high federal funds which in turn influences inflation and over

all interest rates because of the high availability of money.

How does the discount rate affect the decisions of banks in setting their specific interest rates?

The discount rate is the interest rate on secured overnight borrowing by depository

institutions, usually for reserve adjustment purposes. The rate is set by the boards

of Directors of each Federal Reserve Bank. Discount rate changes also are subject to

review by the Board of Governors of the Federal Reserve System. Movements in the

discount rate and its use as a monetary policy tool are described in the Fed's Purpose and

Functions. (http://www.federalreserve.gov/pf/pf.htm). The basic discount rate is adjusted

from time to time, in light of changing market conditions, to complement open

market operations and to support the general thrust of monetary policy. Changes in the

discount rate are made judgmentally rather than automatically and may somewhat lag

changes in market rates. The immediate response of market interest rates partly on the

extent to which the changes in the discount rate, the actual event may have only moderate

effects on market conditions.

As the Fed raises or lowers short- term interest rates, banks may raise or lower the

interest rates they charge borrowers, including the prime rate. Changes in the prime rate

may affect:

You individually. Banks use the prime rate to set rates for credit cards and consumer

loans. If you have an adjustable- rate mortgage or a credit card that has a rate tied to the

prime rate, payments may rise or fall according to the prime rate.

The

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