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The Federal Reserve controls the three tools of monetary policy:

  • open market operations;
  • the discount rate;
  • reserve requirements.

The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee (FOMC) is responsible for open market operations.

The discount rate

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility - the discount window. The Federal Reserve Banks offer three discount window programs to depository institutions: primary creditsecondary credit, and seasonal credit, each with its own interest rate. Under the primary credit program, loans are extended for a very short term (usually overnight) to depository institutions in generally sound financial condition.

Open market operations

FOMC establishes the target range of federal funds rate - the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. The effective federal funds rate is a weighted average of rates on brokered trades.

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