Introduction to Finance

Fed discount rate 
interest rate that 
a bank must pay to borrow from its 
regional Federal Reserve Bank
primary credit rate 
interest 
rate used in practice to refl ect the 
discount rate charged by Reserve 
Banks for loans to depository 
institutions

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C H A PT E R 4 Federal Reserve System
Figure 4.3
shows year-end Fed discount rates charged by Federal Reserve Banks to 
depository institutions to borrow at the discount window beginning in the early 1980s and 
continuing through 2015. Interest rates for 
adjustment credit 
are plotted through 2002 and 
refl ect the rate on short-term loans made available to depository institutions that had tempor-
ary needs for funds not available through “reasonable” alternative sources. Beginning in 2003, 
the discount window interest rate refl ects the primary credit rate. Primary credit is available 
ordinarily for overnight loans to depository institutions in generally sound fi nancial condition. 
In response to the fi nancial crisis and the beginning of the Great Recession, the primary credit 
rate was lowered to 1.25 percent by the end of 2008 and reduced further to .50 percent in 2009. 
In 2010, the primary credit rate was increased to .75 percent and was held at that level through 
most of 2015 in support of the Fed’s easy money policy and quantitative easing eff orts. 
For comparative purposes, year-end bank prime rates, discussed in Chapter 3, are also plot-
ted in Figure 4.3. Recall that the prime rate is the interest rate charged by banks for short-term 
loans to their highest quality business customers. The Fed discount rate and the bank prime rate 
generally “track” each other over time. Both interest rate series peaked in the early 1980s when 
infl ation rates were also very high in the United States. The downward trend in the prime rate has 
generally continued as infl ation rates have also declined. In response to the fi nancial crisis and 
the Great Recession, the prime rate was reduced to 3.25 percent by the end of 2008 and remained 
at that level through most of 2015. In December 2015, the bank prime rate was increased by 
.25 percent to 3.50 percent in response to the Fed increasing the primary credit rate.
Notice that the Fed’s lending rate to depository institutions was consistently lower than 
the bank prime lending rate throughout the time period shown in Figure 4.3. Of course, in 
order to make profi ts, banks must be able to borrow from depositors, and sometimes from the 
Fed, at rates lower than the rates the banks lend at. The determinants of interest rates will be 
discussed in detail in Chapter 8.
Open-Market Operations
The most-used instrument of monetary policy is