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The Federal Reserve

The United States central bank, the Federal Reserve, coordinates the borrowing and lending activities of federally chartered banks. The principal reason the Federal Reserve was created was to reduce severe financial crises. One way of accomplishing this goal is to control the amount of money that flows through the economy. By manipulating the US money supply, the Fed influences inflation, unemployment, and the level of US economic activity.

The Fed has a variety of tools that it uses to control the money supply, but its chief policy tool is the manipulation of "short-term" interest rates.

The Federal Reserve can adjust two distinct "short-term" interest rates:

1.    Discount Rate:  The discount rate is the interest rate which banks pay the Fed for primarily overnight loans.  

2.    Fed Funds Rate:  The Fed funds rate is the rate banks pay to borrow from other banks.

The Federal Reserve has direct control over the level of "short-term" interest rates, the Fed’s influence over longer-term interest rates is less certain.