Introduction
Federal reserve rates is the interest rate moderates overnight borrowing between banks. On the other hand, discount rate is the rates that the Federal Reserve charges on funds that are borrowed by commercial banks from its reserves. The Federal Reserve has been revising the rates that it charges to bring control to the direction of the economy. The latest revision of the rates was done in 2008 where the federal funds rate was reduced to 0% while the discount rate was modified to 0.5%.
The Federal Reserve uses the discount and the federal funds rate to control the direction of the economy (Ilbasy 2010). This is because the changing one of these variables has ripple effects to the whole economy. As an ordinary consumer, the cost of living is the basic consideration as far as changes in interest rates are concerned. As the sole controller of the monetary policy in the US, the Federal Reserve tasked with ensuring that the money flow in the economy is efficient. Changes in these rates have various effects on economic sectors such as employment, investments and living standards of people.
Effects on the consumers
A reduction in interest rates increases public borrowing from financial institutions. This has various effects on ordinary consumers. First, increase in money supply due to excess borrowing raises the prices of commodities. This situation leads to inflation therefore making the cost of living higher. Secondly, borrowed funds can enhance investments since capital is easily accessible. If the rates are moderated, the effect can be optimal with low level of inflation and improved investments.
Effect on borrowing
Mishkin(2007) asserts that low discount rates make bank offer loans at a low interest rate. This makes funds available at low cost therefore interesting a lot more borrowers. This is because the borrowers are in a position to pay the loans. Though it raises the amount of money in circulation, it is a good avenue of providing capital to new investors.
Effects on savers
Low discount rates eat away savings. This is because the low returns discourage the savers from depositing their funds in the banks. As such, the Federal Reserve should devise ways to balance the rates. Savings are important in credit creation by banks thus ways to motivate savings are essential. The latest rates make savers shy away from making deposits. However, the banks have developed new ways to attracts deposits through specialized services such as purchase of goods using debit and credit cards, money transfer services and safekeeping.
Effect on investors
Low interest rates make funds affordable thus increase investments. The government uses these monetary policies to influence the pace of investments. Since the US government is interested in capital growth, the rates act as a motivator. Moreover, low interest rate heightens the banks abilities to mobilize funds to lend to investors. This explains the rationale for revising the rates down.
Effects on bank profits
Banks make funds profits from the interest charge on the loans advanced to clients. If the interest rates are low, then the profits of the banks will be lower. This phenomenon has led to crisis in the banking sector where banks go bankrupt due to stiff operation challenges. However banks in the US have developed measures to maintain their revenues through elaborate effort to increase the customer base. As such, they are able to lend more funds thereby keeping their profits at the desired level.
References
Ilbasy, P. (2010). Revealing the preferences of the US federal reserve. Journal of Applied Econometrics. doi:10.1002/jae.1199
Mishkin, F. S. (2007). Monetary policy strategy. Cambridge, Mass: MIT Press.
SSOAR - Social Science Open Access Repository, McCausland, W David, & Gazioglu, Saziye. (2009). Interest Rates and Monetary Policy.
