Tools of the Fed by dffhrtcv3


									Tools of the Fed

 Discount Window

   Edward Choi
  Monetary Theory
 Discount Window/Discount Rate
• Discount Window
  – Noun: A place where depository institutions borrow
    money from the Federal Reserve

• Discount Rate
  – Noun: An interest rate charged by the Federal
     • Varies among the different regional federal reserve banks
     • Determined by the governors of the each of the district
      Types of Discount Rates
• Primary Credit
   – Only for very short term, usually overnight
   – For financially sound depository institutions as rated by the
     CAMELS rating
   – The interest rate is usually above the FOMC’s target for federal
     funds rate
• Secondary Credit
   – For banks that do not qualify for the primary credit
   – Much more regulation by the Federal Reserve such as the
     requirement and inspection
   – Usually 50 basis points higher than the Primary Credit
• Seasonal Credit
   – Usually longer term borrowers whose industry involves seasonal
     shifts such as farming institutions
   – The rate is the average of the previous two-week average federal
     funds rate and secondary market rate, rounded to the nearest five
     basis points
Federal Reserve Bank of New York
           The Objectives
        the Discount Window
• To provide a safety valve for the
  depository institutions of all sizes in
  cases of sudden changes in their
  assets or liquidity
• Help the Federal Reserve achieve its
  goals, which are in accordance with
  their monetary policy
       Important points from
           the graph…
• The Discount Rate generally moves in
  the same direction as the Target
  Federal Funds Rate

• Since 2003, the Discount Rate started
  to be 100 basis point higher than the
  target fed funds rate.
        The effects of discount rate
              in the economy

If the discount rate is one of the Fed’s three ways to impact the economy,
how does it actually accomplish this goal?

Increase in Discount Rate lowers the BR, which leads to lower money supplied
By the Fed.

      s  m * B  m *( BR  NBR  C )
      To be more specific…
• It is not that the discount rate directly
  affects the amount that is being borrowed
  by the banks. Rather, changes in the
  discount rate affects the least-cost spread,
  thereby affecting the overall BR. This is
  because banks have many options when it
  comes to borrowing money. The Fed is only
  one option out of many.
         BR  A0  A1(ia  id )
• Even the changes that the discount rate
  brings to the money supply is off
  balanced by the Federal Reserve Bank
  of New York doing open market
  operations to affect the interest rate
  – Discount borrowing is usually from about
    400 million to 3.5 billion
  – The Fed uses about 40 billion through its
    open market operations
               Fed Target Rate
                Discount Rate
• No political pressure   • Some political
• No matter what, the       pressure
  rate is determined      • The rate is artificially
  by the market             and administratively

   Allan Meltzer, “They took the position that
   borrowing was a privilege, not a right
• Although the discount window and its
  rate used to be a main method of
  controlling the economy, the Fed, now,
  uses the open market operations for
  that purpose. The discount rate serves
  to be more of a safety valve in the times
  of sudden economic crisis or just a
  regular everyday lender to the banks

To top