[eli5] Why is US federal interest rate highly important in the financial world?
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other comments are saying “this is the rate at which banks borrow from the government”. this statement is true but further clarity may be needed. when we say this, banks are not taking out loans from the government in the same way that a consumer takes out a 30 year mortgage.
banks are constantly dealing with very short term funding mechanics on a daily basis, and they have trading desks dedicated to trading with the federal reserve’s trading desk daily in order to manage the bank’s treasury in what is virtually real time when compared against a long term loan. this daily dealing is where the “federal interest rate”, technically known as the federal discount rate, comes in.
that is also why you may hear the big banks referred to as “federal reserve member banks”. there is a specific group of banks (all the big national household names) that are approved to deal directly with the federal reserve in this way.
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