The discount rate is the interest rates on loans that the Federal Reserves makes banks. Banks occasionally borrow from the Federal Reserve when they find themselves short on reserves. A higher discount rate banks' incentives to borrow reserves from the Federal Reserve, thereby the quantity of reserves in the banking system and causing the money supply to (fall or rise).

The federal funds rate is the interest rate that banks charge one another for short-term loans. When the Federal Reserve uses open-market operations to buy govenment bonds, the quantity of reserves in the banking system , banks' demand for borrowed reserves , and the federal funds rate .

The higher discount rate lower the banks incentive to borrow from the Fed, lowering the quantity of reserves, and causing the money supply to fall.

This is because a higher discount rate makes borrowing from the Fed more expensive. Some of the money that would have been borrowed from the fed becomes bank reserves, and some other becomes loanable funds that increase the money supply. As a result, if banks borrow less from the fed, the money supply falls (or grow less).

The Fed Funds rate is the rate that banks charge one another for short-term overnight loans.

This occurs when banks are stripped of cash, and rely on other banks to meet their cash requirements for the day.

When the Fed buys government bonds, the reserves in the banking system increases, the banks demand for the reserves decreases, and the federal funds rate falls.

When the Fed buys government bonds, it is essentially creating money. This money enters the banking system in the form of reserves, of which some are loaned out, creating even money. Demand for the borrowed reserves falls because banks now need less of it, and as a result, their price: the federal funds rate, also falls.

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