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Interest rates play a key role in the general business cycle and the financial markets. When interest rates change, or interest rate expectations change, the effects are far-reaching. When rates rise, consumers spend less which causes retail sales to slow, which leads to reduced corporate profits, a declining stock market, and higher unemployment.

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Discount Rate

The Discount Rate is the interest rate that the Federal Reserve charges member banks for loans. Banks use the Discount Rate as the base for loans made to their customers. The Discount Rate is set by the Federal Reserve Board which consists of seven members appointed by the President of the United States.

The Discount Rate does not fluctuate on a day-to-day basis like most other interest rates. Instead, it only changes when the Federal Reserve Board feels it is necessary to influence the economy. During recessionary times, the Fed will ease interest rates to promote borrowing and spending. During inflationary times, the Fed will raise interest rates to discourage borrowing and spending, thereby slowing the rise in prices.

Federal Funds

Banks with excess reserves can lend their reserves to banks with deficient reserves at the Federal Funds Market. The interest rate charged for these short (often just overnight) loans is called the Fed Funds Rate.

Prime Rate

The Prime Rate is the interest rate U.S. banks charge their best corporate clients. Changes in the Prime Rate are almost always on the heels of a change in the Discount Rate.


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