What is a Key Rate?
A bank or other institution uses the key rate to determine the interest rate on debt. In the United States, there are two key rates: the discount rate and rate.
How Does a Key Rate Work?
To understand key rates, it is important to understand that banks derive deposits in .
The Federal Reserve Discount Rate
When a bank is unable to meet the reserve requirement, it can borrow those from another bank or directly from the Federal Reserve. If it borrows from another bank, it can get a ; borrowing from the Federal Reserve involves borrowing from 's "Discount Window" at the Discount Rate. The loans are unsecured and are for very short periods (typically overnight).
The is the interest rate banks charge each other on loans used to meet reserve requirements. The Federal Funds Rate is often confused with the Discount Rate.
When a bank is unable to meet the reserve requirement, it can get a Fed . Federal Funds loans are usually made through who specialize in such transactions, or they are made directly between the banks themselves.
Why Does a Key Rate Matter?
The Federal Reserve sets the discount rate, and by doing so it influences the reserve requirements, which makes more money available for lending.
Accordingly, the Federal Reserve can trigger a change in the Federal Funds rate by changing the discount rate. This is why the discount rate and the Federal Funds rate are closely correlated key rates.