Prime Rate Clarification

[rkahn]

I just want to understand this concept...

On Friday, the Fed lowered the prime rate, also known as the federal funds rate, from 6.25% to 5.75%. This is the interest rates that banks like Chase would pay if they ask the Fed for a loan.

In early August, when the Federal Reserve met, it decided to keep its rates at 5.25%, which I believe is called the target rate.

What is the difference between the prime rate (which recently was lowered) and the target rate?

[aiki14]

Originally Posted by rkahn

I just want to understand this concept...

On Friday, the Fed lowered the prime rate, also known as the federal funds rate, from 6.25% to 5.75%. This is the interest rates that banks like Chase would pay if they ask the Fed for a loan.

In early August, when the Federal Reserve met, it decided to keep its rates at 5.25%, which I believe is called the target rate.

What is the difference between the prime rate (which recently was lowered) and the target rate?

The Prime rate is the rate banks charge their best customers and was not affected by the Fed friday morning, it remains at 8.25 where it's been since late june of 2006.
The FOMC lowered the Discount rate (and extended the term of the loans to 30 days) which is actually higher than the Fed funds target rate, and is a short term collateralized loan usually to institutions but can be to anyone if it is determined that not giving the loan adversely affects the economy. The actual Fed Funds Rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight, this is not always the target rate but is usually very close. The FOMC conducts operations to keep it that way.

Here's a reference page with rate comparison graphs:
http://www.moneycafe.com/library/compare.htm

[rkahn]

Can you clarify the difference between the Fed target rate and the Federal Funds Rate? I am still unclear on that

[aiki14]

Originally Posted by rkahn

Can you clarify the difference between the Fed target rate and the Federal Funds Rate? I am still unclear on that

The Fed funds rate is the actual rate the member banks use for overnight loans. The target rate is what the Fed wants the Fed funds rate to be. The FOMC uses three methods to control the rate.
Here's a reference:
http://clevelandfed.org/About/threefrs.cfm

[madcowdisease]

Originally Posted by aiki14

The Prime rate is the rate banks charge their best customers and was not affected by the Fed friday morning, it remains at 8.25 where it's been since late june of 2006.
The FOMC lowered the Discount rate (and extended the term of the loans to 30 days) which is actually higher than the Fed funds target rate, and is a short term collateralized loan usually to institutions but can be to anyone if it is determined that not giving the loan adversely affects the economy. The actual Fed Funds Rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight, this is not always the target rate but is usually very close. The FOMC conducts operations to keep it that way.

Here's a reference page with rate comparison graphs:
http://www.moneycafe.com/library/compare.htm

I could be mistaken but isn't the Fed Funds Rate the rate charged between banks overnight to fulfill the Fed's reserve requirment (currently 10%)? My understanding is that this is the rate that most commonly referred to when discussing th Fed's raising and lowering of rates. The Fed Funds Rate is currently at 5.25% after over two years of tightening 25 basis points at a time. This rate is controlled via open market actions and as such is a target which can fluctuate during these processes.

The discount rate is what the Fed itself charges member banks to borrow directly from the Fed. Set higher than the Fed Funds Rate it is less powerful in its affct on the economy than the more oft tracked Fed Funds Rate.

Am I correct or did I get something mixed up here in my econ classes years ago?

[aiki14]

Originally Posted by madcowdisease

I could be mistaken but isn't the Fed Funds Rate the rate charged between banks overnight to fulfill the Fed's reserve requirment (currently 10%)? My understanding is that this is the rate that most commonly referred to when discussing th Fed's raising and lowering of rates. The Fed Funds Rate is currently at 5.25% after over two years of tightening 25 basis points at a time. This rate is controlled via open market actions and as such is a target which can fluctuate during these processes.

The discount rate is what the Fed itself charges member banks to borrow directly from the Fed. Set higher than the Fed Funds Rate it is less powerful in its affct on the economy than the more oft tracked Fed Funds Rate.

Am I correct or did I get something mixed up here in my econ classes years ago?

I think you're correct with the exception the Federal reserve doesn't really lend money, they buy and sell treasury securities and clear checks on the nations account and such. The 12 Federal Reserve banks and the commercial member banks move overnight cash between themselves at or near the Fed funds rate, I guess technically there is some small risk in lending to the commercial member banks so the rate can fluctuate slightly.
The fed infuences the rate by selling T-Notes, T-Bills,and T-Bonds.

The discount rate, from the Cleveland fed:

"The Federal Reserve System influences the availability of money and credit by changing the discount rate-that is, the interest rate that Reserve Banks charge depository financial institutions for short-term loans of reserves. The Board of Governors sets the discount rate, based on the recommendation of the boards of directors of the 12 Reserve Banks."

The depository financial institutions need not be the member banks, although this is by far the most common, they can be other commercial banks, and in fact other businesses or individuals. I am not sure that the latter has ever occurred but the rules do not specifically forbid it.
Also the discount rate is fully secured, while the Fed funds are not.