Fed Lowers Discount Rate - What Does It Mean?

On Friday, August 17, the Federal Reserve lowered its discount rate from 6.25% to 5.75%. This not to be confused with the Fed Funds Rate, although many Fed-watchers think this means the FOMC will lower that rate at its next meeting on September 18.

The Fed lowered the rate to restore confidence in the financial markets, battered by the ongoing 2007 banking liquidity crisis. The discount rate is the what the Fed charges banks at its discount window. By lowering the rate, the Fed makes it easier for banks to borrow funds needed to maintain their reserve requirement. Normally, banks would borrow from each other, rather than go to the Fed's discount window.

Recently, however, losses from subprime mortgages have motivated banks to charge ever-higher rates to compensate for the risk. The Fed lowered the discount rate to make sure funds are available, especially to smaller banks who can't afford the higher inter-bank lending rates.

What It Means to You

Hopefully, the Fed's action will be enough to calm the financial markets. If not, the Fed has until its next meeting on September 18 to hold out the carrot of lowering the Fed Funds rate. Overall, most analysts say that the global economy is still strong, and should be enough to keep the U.S. economy out of outright recession.

However, keep an eye on economic indicators over the next few weeks to see if the GDP report is revised downwards, and if this subprime mortgage mess starts to affect jobs and consumer spending. Until then, the next few months could continue to be volatile.