10. The discount rate and the federal funds rate The discount rate is the interest rate on loans that the Federal Reserve makes to banks. Banks occasionally borrow from the Federal Reserve when they find themselves short on reserves. A lower discount rate increases banks' incentives to borrow reserves from the Federal Reserve, thereby Increasing * the quantity of reserves in the banking system and causing the money supply to rise The federal funds rate is the interest rate that banks charge one another for short-term (typically overnight) loans. When the Federal Reserve uses open-market operations to buy government bonds, the quantity of reserves in the banking system Increases # , banks' need to borrow from each other rises and the federal funds rate increases