The federal Open Market Operations Committee (FOMC) regulates the money supply, by a combination of three actions: Purchase securities on the open market, known as Open Market Operations, increase or decrease the Federal Discount Rate, lower or raise the Reserve Requirements .
Open market operations consist of the Fed buying and selling previously issued U.S. government securities, or IOUs of the federal government. Reserve requirements are the percentages of certain types of deposits that banks must keep on hand in their own vaults or on deposit at a Federal Reserve Bank. Discount rate is the short term interest rate that the Fed charges banks in the Federal Reserve System for short-term loans. This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. Once these banks have borrowed money from the Fed, they can lend it to other banks at whatever interest rate they want. This is where the Federal Funds Rate comes in.
The Federal Funds Rate is the over night rate banks charge each other as they lend money back and forth. As opposed to the Discount rate, the Federal Funds Rate has more impact on the consumers. In fact, most of the shorter-term interest that consumers pay is tied to the Federal Funds rate -- the target interest rate for overnight loans between high credit-worthy banks. The FOMC sets a target for this rate, but not the actual rate as this is determined by the open market. It is important to note that the discount rate is different from the Fed Funds Rate, which directly impacts interest rates that is paid for Home Equity Lines of Credit, credit cards, and automobile loans. The discount window rate cut does not directly impact mortgage rates. Mortgage rates are determined by the mortgage-backed securities market and most of these bonds are 30 years in duration, whether they are fixed r View More »