Final answer:
An instance where the Federal funds rate is lower than the discount rate suggests that there is a sufficient supply of reserves within the banking system, as banks typically only borrow at the higher discount rate when necessary.
Step-by-step explanation:
If the Federal funds rate is lower than the discount rate, this indicates that the supply of reserves in the banking system is generally sufficient to meet the demand among banks. Because banks prefer to borrow from each other at the lower federal funds rate, they would only resort to borrowing at the higher discount rate when other sources are not enough to meet their needs. This situation suggests that banks are able to find adequate reserves through the federal funds market, which implies a relatively high supply of reserves. Moreover, the Federal Reserve has found that open market operations are a more effective tool in managing monetary policy than altering the discount rate.
The availability of reserves is crucial because it affects the liquidity of the banking system and the overall money supply, thus influencing market interest rates and the economy. However, because most banks borrow little at the discount rate and changing it has little impact on their behavior, the Federal Reserve relies more on open market operations to influence the federal funds rate through the purchase and sale of securities, which directly affects the amount of reserves in the system.