|Open, Says the Fed|
|Subject||Federal Funds Rate|
|Key Words||Federal Reserve, Discount Rate, Federal Funds Rate|
Commercial banks can occasionally find themselves short of reserves.
Banks borrow approximately $60 billion on an average day, and more if
there is a financial crisis. Another alternative is for banks to borrow
directly from the Federal Reserve, although the Fed frowns on repeat borrowers.
The Fed is proposing a change in the way that it loans reserves to member
banks. The Fed proposes to allow greater access to loans in exchange for
higher interest charges.
After the September 11 terrorist attacks, the Fed wanted to ensure that financial institutions had all the funds they needed, so it invited banks to borrow as much as they wanted. Taking advantage of this opportunity, banks borrowed over $45 billion on September 12. This act not only provided needed liquidity, but also reduced the volatility in the Federal Funds market that typically accompanies a financial crisis.
Experience with this policy no doubt contributed to the Fed's latest proposal that banks have open access to the discount window. Under this policy, borrowing will be determined by the market rather than desire to avoid stigma. Bank borrowing will no longer invite an audit; instead banks will pay a premium of 1 percent above the Federal Funds rate. If a bank is in financial difficulty and needs to borrow heavily, the premium would rise to 1.5 percent.
In announcing this proposal, the Fed emphasized that this was not a change
in monetary policy. The discount rate, which has been at or below the
Federal Funds rate, would simply be set above it.
(Updated June 1, 2002)
|Source||John M. Berry, "Proposal Would Remove 'Stigma' From Discount Window," The Washington Post, May 18, 2002.|
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