If the discount rate decreases relative to the federal funds rate, what is likely to happen?

When the discount rate decreases relative to the federal funds rate, it becomes cheaper for banks to borrow funds directly from the Federal Reserve. This lower cost of borrowing incentivizes banks to take out loans from the Fed when they need additional liquidity, as it reduces their overall expenses associated with borrowing. Consequently, a decrease in the discount rate typically leads to an increase in the money supply, as banks have more access to funds, which they can then lend out to businesses and consumers.

Additionally, the relationship between the discount rate and the federal funds rate plays a crucial role. If the discount rate is lower than the federal funds rate, banks will prefer to borrow from the Fed rather than from one another on the open market, leading to a further increase in the money supply. This dynamic showcases the interconnectedness of these rates and emphasizes why understanding their relationship is essential in macroeconomic contexts.