Federal Discount Rate

9 Key excerpts on "Federal Discount Rate"

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  eBook - PDF

  Introduction to Finance

  Markets, Investments, and Financial Management

  • Ronald W. Melicher, Edgar A. Norton(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  The Fed sets the interest rate on these loans to banks and, thus, can influence the money supply by raising or lowering the cost of borrowing from the Fed. Higher interest rates will discourage banks from borrowing, while lower rates will encourage borrowing. Increased borrowing will allow banks to expand their assets and deposit holdings, and vice versa. Loans to depository institutions by the Reserve Banks may take two forms. One option allows the borrowing institution to receive an advance, or loan, secured by its own promissory note together with “eligible paper” it owns. In the second option, the borrower may discount – or sell to the Reserve Bank – its eligible paper, which includes securities of the U.S. government and federal agencies, promissory notes, mortgages of acceptable quality, and bankers’ acceptances. This discounting process underlies the use of the terms “discount window” and “discount rate policy.” The Fed’s lending rate policy was originally intended to work in the following fashion. If the Fed wanted to cool an inflationary boom, it would raise the discount rate. An increase in the discount rate would lead to a general increase in interest rates for loans, decreasing the demand for short-term borrowing for additions to inventory and accounts receivable. This, in turn, would lead to postponing the building of new production facilities and, therefore, to a decreased demand for capital goods. As a consequence, the rate of increase in income would slow down. In time, income would decrease and with it the demand for consumer goods. Holders of inventories financed by borrowed funds would liq- uidate their stocks in an already weak market. The resulting drop in prices would tend to stimulate the demand for, and reduce the supply of, goods. Thus economic balance would be restored. A reduction in the discount rate was expected to have the opposite effect.

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  eBook - ePub

  Handbook of Monetary Policy

  • Jack Rabin(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Discount rate Interest rate at which an eligible depository institution may borrow funds, typically for a short period, directly from a Federal Reserve Bank. The law requires that the board of directors of each Reserve Bank establish the discount rate every fourteen days subject to the approval of the Board of Governors.

  Equilibrium real interest rate The level of the real interest rate that is consistent with the level of long-run output and full employment.

  Excess reserves Amount of reserves held by an institution in excess of its reserve requirement and required clearing balance.

  Federal funds rate The interest rate at which banks borrow surplus reserves and other immediately available funds. The federal funds rate is the shortest short-term interest rate, with maturities on federal funds concentrated in overnight or one-day transactions.

  Fiscal policy Federal government policy regarding taxation and spending; set by Congress and the Administration.

  Foreign currency operations Purchase or sale of the currencies of other nations by a central bank for the purpose of influencing foreign exchange rates or maintaining orderly foreign exchange markets. Also called foreign-exchange market intervention.

  Foreign exchange rate Price of the currency of one nation in terms of the currency of another nation.

  Government securities Securities issued by the U.S. Treasury or federal agencies.

  Gross Domestic Product (GDP) The total market value of a nation’s output of goods and services. GDP may be expressed in terms of product—consumption, investment, government purchases of goods and services, and net exports—or, it may be expressed in terms of income earned—wages, interest, and profits.

  Inflation

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  eBook - PDF

  Mathematical Interest Theory

  Third Edition

  • Leslie Jane Federer Vaaler, Shinko Kojima Harper, James W. Daniel(Authors)
  • 2019(Publication Date)
  • American Mathematical Society

    (Publisher)

  The rate charged by the Federal Reserve for banks to directly bor-row from the Federal Reserve is called the discount rate . 12 If a large number of banks are experiencing higher than normal withdrawal volume, then the central bank will provide limited support to all that require assistance. In this situation, bank customers may only be allowed to make limited withdrawals for a specified time period. The Federal Reserve is also known as the Federal Reserve System because it consists of several parts: the Board of Governors , the twelve Re-gional Reserve Banks, and the Federal Open Market Committee 12 Note that this is different from the discount rate discussed in Chapter 1. 528 Chapter 10 Determinants of interest rates (FOMC). The Board of Governors is also known as the Federal Reserve Board (FRB). The seven members of the Board of Governors are appointed by the Pres-ident of the United States and confirmed by the U.S. Senate for a term of fourteen years. The terms are staggered, with one appointed every two years. The staggering is meant to limit the number of Governors that a single U.S. President can nominate, insulating the Board from the day-to-day political pressures from the administration. The Board of Governors supervises the work of the Federal Reserve and issues banking and consumer-credit regula-tions. The Federal Open Market Committee has twelve voting members: the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four other presidents of the regional Federal Reserve Banks that serve one-year terms on a rotating basis. Note that the Board of Governors has more than half of the twelve votes. The federal funds rate is the interest rate that banks charge each other for overnight loans, using the excess from the reserves they keep with the Federal Reserve.

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  Federal Reserve Policy Reappraised, 1951–1959

  • Daniel S. Ahearn(Author)
  • 2019(Publication Date)
  • Columbia University Press

    (Publisher)

  VII THE USE OF THE DISCOUNT MECHANISM AT THE SAME TIME that the Federal Reserve Board was narrowing the scope of open-market operations, it was attempting to make the discount mechanism a major tool of monetary policy. 1 The contrast meant no contradiction in basic policy, however. Both decisions were consistent with the Federal Reserve Board's preference for restrict-ing itself to traditional methods of credit control, for giving free mar-ket forces maximum scope, and for affecting the volume rather than the cost of credit. Discounting, after all, was the traditional way in which central banks had exerted influence over the money market. Moveover, since discounting is done at the request of member banks, it gives private market forces the primary initiative. And, in at least the early stages of the post-Accord revival of the discount mecha-nism, the Federal Reserve authorities evidently envisaged its main importance as lying in the volume of funds borrowed rather than in the rate charged on the borrowings. The Federal Reserve soon found that its ambitious conception of 1 Under the discount mechanism the Federal Reserve Banks make short-term loans to their member banks on the security of eligible commercial paper or (more important in recent years) on the security of Treasury securities at a rate of interest—the discount rate—which is changed from time to time in ac-cordance with the economic situation and credit conditions. See, Board of Gov-ernors of the Federal Reserve System, The Federal Reserve System, Purposes and Functions (Washington, D.C., 1954), Ch. III. When the Federal Reserve Act was enacted in 1913 the discount mechanism and rate were regarded as the principal, if not the only, instrument of monetary policy. During the 1920s, discounting remained important though open market operations assumed in-creasing prominence.

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  Market-Based Interest Rate Reform in China

  • China Finance 40 Forum Research Group(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  It is necessary to point out that the approaches focusing on open market operations and the interest rate corridor are complementary and interconnected. Refinancing (rediscount) is common among almost all central banks. Only some central banks do not pay interest on financial institutions’ deposits (one-side interest rate corridor). After the 2008 global financial crisis, both the US and Japan started to pay interest on (surplus) reserve, leading to the emergence of interest rate corridors and deposit and lending facilities. Adjustment through the interest rate corridor has become a trend (Hu, 2014). At the end of 2008, the Federal Reserve started to pay interest on depository institutions’ required and surplus reserves. Currently, the Federal Reserve pays an interest of 1.25 percent (the upper limit of federal funds rate target) on surplus reserve, which actually imposes a lower limit on money market rates. Regarded as the lending facility rate, the Federal Discount Rate is 1.75 percent at the moment. The target range of the federal funds rate is 1–1.25 percent and it seems unlikely for the rate to be zero. Therefore, the Federal Reserve’s interest rate corridor covers a range of 50 basis points. However, institutions outside the Federal Reserve System cannot get interest on their reserves and are thus willing to lend money at a rate lower than the lower limit of deposit rates. Therefore, the effective federal funds rate remains 10 to 15 basis points below the target (Bech and Klee, 2011). As discount business decreases, the Federal Reserve manages liquidity mainly through open market operations. Deposit and lending facilities are less frequently used and less effective in interest rate guidance. The Federal Reserve achieves its monetary policy objectives mainly through open market operations. Japan’s situation is similar to that in the US. In Japan, however, the target rate is at a lower level (near zero).

  The ECB will remunerate minimum reserve holdings at a level corresponding to the rate of its main refinancing operations (MRO). In July 2012, the MRO rate dropped to 0.75 percent and the rate under the deposit facility dropped to zero. Faced with a weak economy and potential deflation, on June 11, 2016, the ECB lowered the MRO rate by 10 basis points to 0.15 percent, overnight deposit rate (0 percent originally) by 10 basis points to −0.1 percent, and overnight lending rate by 35 basis points to 0.4 percent. These measures were applied to eurozone countries, thus initiating an age of negative rates. On September 10, 2014, the ECB further cut the MRO rate to 0.05 percent (a near zero level), deposit facility rate to −0.2 percent, and marginal lending facility rate to 0.3 percent. Therefore, as policy rates are near zero bound, ECB takes a similar approach as the US before the financial crisis. The market rates face an upper limit (the rate under marginal lending facility) but no effective lower limit. Market rates fluctuate around the target level and move closer to zero bound.

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  Experiments in Credit Control the Federal Reserve System

  • Caroline Whiitney(Author)
  • 2019(Publication Date)
  • Columbia University Press

    (Publisher)

  4 The former guide refers to short term interest rates and the latter to rates ruling on the capital markets. The Federal Reserve Banks and Short-term Interest Rates Short term interest rates are of two distinct types; open market interest rates, or rates ruling on paper which is dis-counted by some holder other than the one with whom the borrower originally negotiated the loan, and rates ruling at banks on paper which is held by them until maturity. The former, open market interest rates, always exhibit changes before the latter, customer rates. Among the factors which the Reserve banks consider sufficiently potent to influence interest rates are ( 1 ) the dis-count rate and (2) open market holdings of government securities and of bankers' acceptances. The discount rate as an influence causing changes in open market interest rates was eliminated by Riefler, who observed that discount rates have always been changed after open market interest rates have changed. 5 With this conclusion we cannot quarrel because Riefler's charts offer final evidence for his conclusion. Riefler found that the volume of bills discounted influences interest rates. The Federal Reserve banks also attempt to influence the money market through open market operations. Originally engaged in to provide Reserve banks with earning assets, to 4 Chap, ii, pp. 29 and 37. 6 Winfield W . Riefler, Money Rates and Money Markets in the United States, N. Y., 1930, p. 24. I5 6 FEDERAL RESERVE SYSTEM stabilize certain parts of the money market or to influence the money market temporarily pending a change in the dis-count rate, these operations have come more and more to occupy an independent position among the tools of credit control. The Federal Reserve banks have claimed that they are effective and that a decline in interest rates has always followed purchases of government bonds. Such a consequence logically follows a release of funds at the chief financial center or the country—New York City.

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  eBook - ePub

  Bank Investing

  A Practitioner's Field Guide

  • Suhail Chandy, Weison Ding(Authors)
  • 2021(Publication Date)
  • Wiley

    (Publisher)

  Similar to the fed funds target, permanent open market operations influence the operating environment for banks. Higher longer-term rates will naturally benefit yields on certain loans benchmarked to those rates (like mortgage and CRE). However, the offset is that a tighter environment could dampen demand for those types of loan products, making growth incrementally harder.

  The Discount Rate and Discount Window represents the interest rate charged to banks on collateralized loans they receive from their regional Federal Reserve Bank's lending facility, known as the discount window. There are actually three separate rates at play here: primary credit, secondary credit, and seasonal credit. The primary credit program is usually an overnight loan, made to banks in sound financial condition. The rate is set at 50 bps over the fed funds target. Secondary credit is used to meet short-term liquidity needs or to resolve severe financial difficulties for those depositories ineligible for primary credit. The rate is set at 50 bps over the primary credit rate (i.e., 100 bps over the fed funds target). Seasonal credit is usually extended to small banks that deal with some form of seasonality in their business (i.e., agriculture). There is some stigma for financial institutions that tap the discount window, as the implication is that a bank tapping the discount window is suffering from liquidity issues and is unable to access other funding.

  The Reserve Requirement is one of the oldest tools available to central banks, and represents the amount of funds that a bank needs to hold in either vault cash or deposited at the Federal Reserve against deposits (Exhibit 7.13 ). This is to ensure that banks will have sufficient liquidity to handle depositor withdrawals. Fractional reserve banking is possible because banks are not required to hold a 100% reserve against their deposits. Thus, the reserve ratios are an important lever for the Federal Reserve to control credit. Higher reserve ratios will mean less lending activity, while lower reserve ratios will mean more lending activity.

  The Money Multiplier

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  Discounting for Time and Risk in Energy Policy

  • Robert C. Lind, Kenneth J. Arrow, Gordon R. Corey, Partha Dasgupta, Amartya K. Sen, Thomas Stauffer, Joseph E. Stiglitz, J.A. Stockfisch(Authors)
  • 2013(Publication Date)
  • RFF Press

    (Publisher)

  2 Robert C. Lind A Primer on the Major Issues Relating to the Discount Rate for Evaluating National Energy Options Introduction

  The purpose of this chapter is to introduce the reader to the central issues in the controversy over the choice of the discount rate for evaluating federal energy projects and policies and to develop a way to make specific recommendations on the selection of this rate and on procedures for evaluating federal policies and projects. The question of what rate of discount is appropriate for use in the evaluation of federal projects, that is, what is the social rate of discount, is complex and continues to be the subject of controversy among professional economists. This chapter is an attempt to lay out the major elements of the controversy in a manner that will make it accessible to readers with some knowledge of economics, but who are not professional economists, and to professional economists who have not followed the literature on this issue. The exposition relies largely on simple numerical examples, and the reader need not be familiar with the mathematical techniques employed in much of the recent literature on this subject. The reader who is conversant with the literature may also benefit from an organized review of the issues and have an interest in the analytical method that is developed to provide guidance to policy makers on the choice of the discount rate.

  Five concepts are central to the discussion of the choice of the social rate of discount, which is the rate that should be used to compute the present values of benefits and costs of public investments and public policies if decisions based on these benefit–cost analyses are to be optimal; that is, benefit–cost analysis using the social rate of discount will direct policy makers to the correct decision from a social perspective. These concepts are (1) the social rate of time preference, which is the rate at which society is willing to exchange consumption now for consumption in the future; (2) the consumption rate of interest, which is the rate at which individual consumers are willing to exchange consumption now for consumption in the future; (3) the marginal rate of return on investment in the private sector; (4) the opportunity cost of a public investment, that is, the value of the private consumption and investment forgone as a result of that investment; and (5) risk, which is related to the degree to which variation in the outcome of a public project will affect variation in the payoff from the nation’s total assets. These concepts will be introduced and discussed as issues pertaining to the choice of the social rate of discount are developed.

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  Explaining and Forecasting the US Federal Funds Rate

  A Monetary Policy Model for the US

  • M. Clements(Author)
  • 2003(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  INTRODUCTION The Fed describes monetary policy as ‘actions undertaken ... to influ- ence the availability and cost of money and credit to help promote national economic goals’. The Federal Reserve Act specifies that in conducting monetary policy, the Federal Open Market Committee (FOMC) should seek ‘to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates’. The Fed controls the three main tools of monetary policy: open market operations (the FFR), the discount rate, and reserve require- ments. This book examines only the FFR, which is influenced by open market operations, the buying and selling of securities, which is the Fed’s primary instrument for controlling monetary policy. The FOMC is responsible for open market operations and setting the FFR. The committee comprises 12 voting members and meets at eight scheduled meetings a year. The FFR is the interest rate at which depository institutions (banks) lend balances at the Fed to each other overnight. Changes in the FFR in turn affect other interest rates, both long and short term, such as government and corporate bonds, mort- gage and credit rates. The exchange rate of the dollar is also sensi- tive to changes in the FFR. Using this rate, the Fed can affect the price of money and credit. In this way it influences employment, output and inflation. Strictly speaking, the Fed’s mandate of ‘price stability’ is a misnomer. Price stability means, by definition, zero inflation. Also, CHAPTER 2 Monetary Policy at the US Federal Reserve 27 the mandate does not specify which inflation measure should be targeted. In reality, the Fed looks to achieve inflation stability using an inflation measure that it considers to best represent price move- ments across the economy. In February 2000, the Fed ostensibly signalled a preference for the Commerce Department’s Personal Consumption Expenditure (PCE) price index as its chosen inflation measure.

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