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Tools of The Federal Reserve: Discount Rates and Reserve Requirements

Decent Essays
Discount Rate
The Federal Reserve uses two other types of tools besides the open market operations (OMO), and they are the discount rates and reserve requirements. The FOMC is responsible for the OMO and the discount rate and reserve requirements are taken care by the Federal Reserve System’s Board of Governors. The three fundamental tools can influenced the demand and supply of and the balances that depository institution hold which can result in the change in federal funds rate.
In 1913, the Federal Reserve System was enacted, it has three primary objectives; eradicating the “pyramiding” of reserves in New York City and substitute it with a polycentric system of twelve reserve banks, which will help the banks with a more seasonal
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Furthermore, depository institutions that do not meet the requirements for primary credit but needs a short-term loan for liquidity purposes can still use secondary credit. Higher level of administration is necessary for secondary credit due to the institution being less stable than those who are eligible for the primary credit. Thus, secondary credit is priced slightly higher than the primary credit.
Lastly, seasonal credit is normally served to smaller depository institutions that needs constant loans due to the nature of the business being seasonal, thus the institutions would incur recurring fluctuations in funding needs. Examples of businesses that are under seasonal credit are banks in agricultural and seasonal resort communities. Seasonal credit is offered to small depository institutions to allow smooth operation during tough months when there is low to no income. Seasonal credit can last for up to 90 days. The discount rate for seasonal credit is an average of the chosen market rates (Board of Governors of the Federal Reserve System, 2013).
Reserve Requirements
Reserve requirements as defined by the Board of Governors of the Federal Reserve System (2013) are “the amount of funds that a depository institution must hold in reserve against specified deposit liabilities”. The Board of Governors has the rights to change the reserve requirements, within limits specified by law (Board of
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