discount rate

(noun)

An interest rate that a central bank charges to depository institutions that borrow reserves from it.

Related Terms

Examples of discount rate in the following topics:

  • The Discount Rate

    • The rate that member banks charge each other is the federal funds rate and the rate the Fed charges is referred to as the discount rate.
    • The rate that member banks charge each other is referred to as the federal funds rate and the rate the Fed charges banks is referred to as the discount rate.
    • The discount rate is the rate that the central bank actual controls.
    • That is the rate banks charge each other, and is influenced by the discount rate.
    • In this manner, the discount rate in tandem with the fed funds target rate are part of an expansionary policy mechanism.

  • The Creation of the Federal Reserve

    • The Fed extends these loans through the discount window and charges what is called the discount rate.
    • The discount rate is set by the Fed, and is important because it radiates throughout the economy: if it becomes more expensive to borrow at the discount window, interest rates will rise and borrowing will become more expensive economy-wide.
    • In this way, the Fed can use the discount window to affect interest rates and the money supply .
    • Recall that the interest rate that the government pays is determined by the price of the bond: the higher the price of the bond, the lower the interest rate.
    • By extension, OMOs change the interest rate, hopefully to achieve one of the Fed's monetary goals.

  • The Effect of Expansionary Monetary Policy

    • Increasing the money supply also decreases the interest rate, which encourages lending and investment.
    • As a result, the interest rate for loans decrease.
    • Another way to enact an expansionary monetary policy is to increase the amount of discount window lending.
    • Decreasing the rate charged at the discount window, the discount rate, will not only encourage more discount window lending, but will put downward pressure on other interest rates.
    • Low interest rates encourage investment .

  • Managing the Business Cycle

    • Expansionary monetary policy relies on the central bank increasing availability of loanable funds through three mechanisms: open market operations, discount rate, and the reserve ratio.
    • As the supply of loanable funds increases, the interest rate is expected to decrease and thereby increase the desire to borrow funds for consumption and investment purposes.

  • Money in the U.S. Economy

    • The rate on such loans, known as the "federal funds rate," is a key gauge of how "tight" or "loose" monetary policy is at a given moment.
    • The Fed's third tool is the discount rate, or the interest rate that commercial banks pay to borrow funds from Reserve Banks.
    • By raising or lowering the discount rate, the Fed can promote or discourage borrowing and thus alter the amount of revenue available to banks for making loans.
    • In this situation, interest rates tend to drop, business spending and consumer spending tend to rise, and employment increases; if the economy already is operating near its full capacity, too much money can lead to inflation, or a decline in the value of the dollar.
    • In this situation, interest rates tend to rise, spending levels off or declines, and inflation abates; if the economy is operating below its capacity, tight money can lead to rising unemployment.

  • Open Market Operations

    • These include the discount rate, the fed funds target rate, and the reserve requirement, and open market operations (OMOs).
    • Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate--the interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC.
    • In an expansionary platform, the OMO will seek to increase the money supply and reduce interest rates in order to promote economic growth.
    • The interest rate targeted through the OMO manipulation of the money supply is the fed funds target rate or the rate that member Fed banks charge one another for overnight loans.
    • In addition to this direct interest rate channel, the fed funds rate influences many other interest rates in the economy and by so doing contributed to either incentivizing borrowing for growth or disincentivizing the same.

  • The Federal Reserve and the Financial Crisis of 2008

    • Lower interest rates stimulate loans, spending, and investment and help an economy escape from recession.
    • The Federal Reserve (the Fed) did engage in these types of conventional operations in 2007 and 2008, cutting the target federal funds rate and the discount rate seven times.
    • When inflation is high, however, central banks may be able to push the real interest rate below 0%.
    • Recall that the nominal interest rate is the sum of the real interest rate and the expected inflation rate.
    • If the nominal interest rate is 1% and inflation is 3%, the real interest rate is -2%.

  • The budget constraint: balancing income, consumption, and saving across time

    • As a result, four different models attempted to explain the affect of time on consumption and saving decisions: Fisher's Model of Intertemporal Consumption, Modigliani's Life Cycle Income Hypothesis, Friedman's Permanent Income Hypothesis, and Hyperbolic Discounting.
    • All of the other models discussed discount future periods exponentially using the same interest rate.
    • Some economists argue that such a consistent means of discounting consumption and saving is not realistic.
    • They argue individuals are often affected by temporal myopia, where they respond to uncertainty by reducing the importance of the future of their decision making.This is called hyperbolic discounting.

  • Elasticity Conditions for Price Discrimination

    • Discounts based on occupation: many businesses offer reduced prices to active military members.
    • Less publicized discounts are also offered to off duty service workers such as police.
    • They include rebates, bulk and quantity pricing, seasonal discounts
    • Gender based discounts: gender based discounts are offered in some countries including the United States.
    • In contrast, men usually have higher car insurance rates than women based on the likelihood of being in an accident based on their age.

  • The Effect of Restrictive Monetary Policy

    • Increasing the money supply also increase the interest rate, which discourages lending and investment.
    • The higher interest rate also promotes saving, which further discourages private consumption.
    • As a result, the interest rate for loans increase.
    • The higher interest rates also can slow inflation.
    • Another way to enact a contractionary monetary policy is to decrease the amount of discount window lending.