The Fed charges banks that borrow from the central bank itself for short periods.

The Federal Reserve on Thursday raised its discount rate to 0.75% from 0.5%, an effort to return its lending facilities to more normalized levels.
The Fed said the move, along with other recent modifications to its credit programs, does not signal a change in its outlook for the economy or for monetary policy, and the more important fed funds rate remains in its range of 0% to 0.25%.
The Fed usually changes the discount rate at the same time it does the fed funds rate, but after the unprecedented steps taken to combat the financial crisis, the Fed is eager to start bringing rates back to more traditional levels, and Thursday’s move is a start.
The discount rate is the interest rate the Fed charges banks that borrow from the central bank itself for short periods. Last week, Federal chairman Ben Bernanke said the Fed was mulling a “modest increase” in the discount rate “before long,” saying the bump up “should be viewed as further normalization…in light of the improving conditions in financial markets.”
Futures on stock market indexes pulled back immediately following the announcement, with Dow futures down nearly 50 points. The Dow gained better than 80 points on Thursday. Treasury prices pulled back, sending their yields higher.
Also Thursday, the Fed said that effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight, and raised the minimum bid rate for the Term Auction Facility [TAF] by a quarter percentage point to 0.5%.
“The increase in the discount rate announced Thursday widens the spread between the primary credit rate and the top of the FOMC’s 0 to 0.25% target range for the federal funds rate to one-half percentage point,” the Fed said. “The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve’s primary credit facility only as a backup source of funds. The Federal Reserve will assess over time whether further increases in the spread are appropriate in view of experience with the one-half percentage point spread.”
Thursday’s move comes as the Fed continues to assess a mixed bag of economic data. The employment picture remains muddled, unable to build momentum while other signs of economic life are emerging.
At the height of the global financial crisis, one of the first moves by the U.S. central bank was to reduce the spread of the primary credit rate over the FOMC’s target for the fed funds rate to half a percentage point from one percentage point.
The Fed also lengthened the typical maximum maturity from overnight to 30 days.
A few months later, in December 2007, the Fed created the TAF to improve the access of banks to term funding. Then, in March 2008, the Fed cut the spread of the primary rate over fed funds to a quarter percentage point and extended the maximum maturity of primary credit loans out to 90 days.
As the economy started showing signs of life last year, and credit markets appeared to be unthawing, the Fed started to reduce TAF auction sizes and last month started the process of normalizing the terms on primary credit by reducing the typical maximum maturity back to 28 days.