Economics Questions

Re: The Fed's "Discount Rate"

chloe732 — Sun, 14 Feb 2010 05:04:30 GMT

Think Blue:
Discount rate is the interest rate the Fed charges for a bank to borrow funds from it. The Fed is understood to be a lender of last resort, so would actually discourage a bank to use the Fed as the primary source of funding. Therefore the Fed would set the discount rate at a penalty rate above the Federal funds rate.

In "normal" times, yes (if there is such a thing as "normal" under a central bank regime). But in Sept. '08, this all changed. The Fed encouraged banks to "come to the window" and actually made public announcements that there is no stigma involved by doing so. Then they invented all the alphabet soup "lending programs" to push money into the system.

I think my question is answered; the discount rate is an arbitrary rate the Fed essentially "posts to a bulletin board" without the need for intervention in open markets.

"It's not a liquidity trap, just a broke banking system, I'm done, that's a rap..." - Hayek rap video.

Re: The Fed's "Discount Rate"

Think Blue — Sun, 14 Feb 2010 03:58:25 GMT

Caley McKibbin:

Think Blue:

For a member bank to borrow funds from the Fed at the discount window would make the Fed suspicious. This would seem to indicate that no other member banks wants to lend funds to this bank.

Suspicious of what? Why would they care?

That the member bank may be in trouble and the Fed would have to intervene.

Re: The Fed's "Discount Rate"

Caley McKibbin — Sun, 14 Feb 2010 03:53:56 GMT

Think Blue:

For a member bank to borrow funds from the Fed at the discount window would make the Fed suspicious. This would seem to indicate that no other member banks wants to lend funds to this bank.

Suspicious of what? Why would they care?

Re: The Fed's "Discount Rate"

Think Blue — Sun, 14 Feb 2010 03:42:39 GMT

chloe732:

I understand the mechanism the Fed used in order to "target" the "fed funds" rate (until the advent of ZIRP), but I have a question about the "discount rate". Is it merely a rate they announce, and start charging to banks who borrow at the discount window? It used to be set about .25% above fed funds. Or, is it somehow manipulated, or targeted, like fed funds?

I ask this because it seems the discount rate will come into play more now that the Fed has shifted into paying interest on excess reserves as a means to manipulate (or restrict) the creation of money by the banking system.

Federal funds rate is the interest rate the member banks charge in lending excess reserves to each other. The rate is determined by private agreement between the lending and the borrowing bank.

Previously, the Fed influenced the rate through open market operations. But now, this is done through the Fed paying interest on the excess reserves a member bank deposits at the Fed. This sets a minimum rate a bank is willing to lend to another bank.

Discount rate is the interest rate the Fed charges for a bank to borrow funds from it. The Fed is understood to be a lender of last resort, so would actually discourage a bank to use the Fed as the primary source of funding. Therefore the Fed would set the discount rate at a penalty rate above the Federal funds rate.

For a member bank to borrow funds from the Fed at the discount window would make the Fed suspicious. This would seem to indicate that no other member banks wants to lend funds to this bank. Thus the bank would borrow from the Fed only as a last resort.

Re: The Fed's "Discount Rate"

Chris — Sat, 13 Feb 2010 19:21:25 GMT

The discount rate is not targeted it is set by the Fed. Historically the spread between the Fed funds rate and discount rate has been higher, around a full percentage point I believe. The Fed would simply say: "The discount rate is 0.5%. Any bank that wants to directly borrow directly from us will pay 0.5%" Simple as that.

Also keep in mind that the payment of interest on reserves increases the creation of money because where does the Fed get the money to pay the interest? They create it. Of course, the higher this rate goes the less likely it is that banks will lend elsewhere and thus this will further delay the upward pressure on prices.

The Fed's "Discount Rate"

chloe732 — Sat, 13 Feb 2010 06:08:30 GMT

I understand the mechanism the Fed used in order to "target" the "fed funds" rate (until the advent of ZIRP), but I have a question about the "discount rate". Is it merely a rate they announce, and start charging to banks who borrow at the discount window? It used to be set about .25% above fed funds. Or, is it somehow manipulated, or targeted, like fed funds?

I ask this because it seems the discount rate will come into play more now that the Fed has shifted into paying interest on excess reserves as a means to manipulate (or restrict) the creation of money by the banking system.