Discount Rate, Federal Funds Rate and R*
The current issue between Donald Trump and Federal Reserve Chair Jerome Powell centers on Trump's strong dissatisfaction with Powell's refusal to cut interest rates quickly enough, especially in the context of Trump's aggressive tariff policies.
The conflict between Donald Trump and Federal Reserve Chair Jerome Powell is not new; Trump has criticized Powell since his appointment in 2018, and the tension has escalated as economic uncertainty has grown due to tariffs and market volatility. While Trump has suggested he might try to remove Powell, legal and institutional safeguards make such an action highly unlikely, and Powell has reiterated that the Fed will act independently and in the best interests of the American economy.
We will not address the Federal Reserve’s independence in this article. Instead, our focus will be on a concept that falls within the Federal Reserve’s core responsibilities.
We will explore three important rates: the Discount Rate, the Federal Funds Rate and R-star (R*).
These are important concepts in monetary policy, but they serve different purposes.
Discount Rate
The discount rate is the interest rate the Federal Reserve charges commercial banks and other financial institutions for short-term loans through its lending facility known as the "discount window". This rate is set by the Fed and serves as a tool of monetary policy, influencing liquidity and credit conditions in the banking system. When the Fed raises the discount rate, borrowing becomes more expensive for banks, which can slow economic activity. Lowering the rate makes borrowing cheaper, encouraging lending and economic growth.
The US Discount Rate is currently at 4.50%.
Federal Funds Rate
The Federal Funds Rate is the target interest rate set by the Federal Open Market Committee (FOMC) at which commercial banks borrow and lend their excess reserves to each other overnight. The current federal funds rate target range is 4.25% to 4.50%.
It's a tool used by the Fed to influence broader interest rates in the economy and manage inflation, employment, and economic growth.
Changes in this rate affect various consumer interest rates, including those for mortgages, credit cards, and savings accounts.
R-star (R*)
When evaluating interest rate policy, economists consider the natural rate of interest—referred to as R* or R-star—which represents a neutral stance, indicating that monetary policy is neither restrictive nor expansionary. In essence, R* serves as the equilibrium point.
Upgrade to a paid subscription to unlock access to detailed entry and exit points for our trades, real-time trade updates, and expert insights into macroeconomics and finance. Subscribers will also gain exclusive access to advanced options trading strategies and the methodologies behind structuring these trades.