Final answer:
If the federal funds rate is lower than the discount rate, banks are incentivized to borrow from each other rather than the Federal Reserve.
Step-by-step explanation:
When the federal funds rate is lower than the discount rate, it discourages banks from borrowing directly from the Federal Reserve to meet their required reserves
Instead, banks are more likely to borrow from other available sources, such as other banks, due to the cheaper costs associated with the federal funds rate.
Historically, the Federal Reserve has preferred banks to use the federal funds market for overnight borrowing, which has led to the discount rate typically being set higher than the federal funds rate.
The Fed has found that open market operations are a more effective tool for conducting monetary policy rather than changing the discount rate.
When the discount rate is adjusted, it doesn't significantly impact banks' borrowing behaviors since they borrow little at this rate. Therefore, if the federal funds rate is lower than the discount rate.
It is typically an intentional strategy to steer banks towards borrowing from each other rather than relying on the Federal Reserve as a lender of last resort.