Th Fed raised the discount rate by 25 bps to 75 bps. Some are saying that this signifies a change in policy. The exit has started. The signal is clear. Still this action has to be placed in context. The discount rate borrowings have been dropping and now only represent $87 billion. This was after the borrowings hit $400 billion in October 2008. This is a normalization of monetary policy but will not have a strong effect on the overall Fed balance sheet or the monetary base. The monetary base is at $2 trillion so even if all discount borrowings disappeared the impact would only be 4%. There are more than enough excess reserves that banks should be able to access funds from other banks at a cheaper price. The discount rate is now a penalty rate which is usually what normal Fed behavior has been.
The increase in 25 bps will mean an increase cost to those borrowing money of about $217 million per year. One will expect that the borrowings will decline even more in the coming weeks. What is an issue is the composition of the borrowers for the $87 billion. This is not clear whether these borrowers have access to other funds.
Overall, this action has a strong announcement effect that the Fed is serious about normalizing monetary policy. However, the key move is what will happen with the mortgage purchase program which ends this quarter.
The increase in 25 bps will mean an increase cost to those borrowing money of about $217 million per year. One will expect that the borrowings will decline even more in the coming weeks. What is an issue is the composition of the borrowers for the $87 billion. This is not clear whether these borrowers have access to other funds.
Overall, this action has a strong announcement effect that the Fed is serious about normalizing monetary policy. However, the key move is what will happen with the mortgage purchase program which ends this quarter.
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