The Fed Did What Exactly?

So, the Federal Reserve came out today and said they were raising the discount rate 25 basis points from 50 to 75 (or, 0.5% to 0.75%). Now, from my previous blog posts, you'd think that I'd be up in arms about this, saying that it's a bad move and will do more harm than good and lead to more unemployment. However, that is not my opinion. In fact, the raising of the discount rate doesn't really do anything to worry me for a few reasons:

1. The discount rate is the rate at which banks borrow directly from the Federal Reserve's discount window. Banks typically don't borrow directly from the Federal Reserve for a few reasons. First, it means they have to show the Fed their balance sheet which could lead to a shut down. Second, it shows that they couldn't raise the money through normal channels and needed help from the government. This could potentially cost them their FDIC insurance for the same reason the Fed would shut them down. So really, all that has changed is the price of a tool banks very rarely use. The federal funds rate, which is the rate at which banks borrow from each other, is still being held between 0% and 0.25%. When that goes up, there could be a problem.

2. Banks aren't really lending right now. If banks were actually lending, the discount rate could matter (of course, if banks were lending all the interest rates would be higher than they are now). Banks that don't lend typically don't need to borrow emergency funds. So again, they wouldn't really be using the discount window to borrow.

3. Fed Chairmen Ben Bernanke told congress last week that this was going to happen. Therefore, it really isn't a surprise. Investors have had time to plan and account for this, so this increase in the discount rate shouldn't really send the markets into a panic (shouldn't being the operative word).

Now, it is true that this does have an effect on the overall economy. The dollar, for example, rose in value which is good (not a lot, but a little). But really, it's not that big of a deal. After all, the market us used to having the discount rate be higher than the fed funds rate by about 1%, so it's still lower than normal. Mostly, I feel the Fed did this to show that it was ready to pull back on the stimulus when needed and to try and give the dollar a small boost, neither of which are surprising. However, if the Fed decides to raise the Federal Funds rate at all while the economy is still sluggish, we could be in real trouble. For now though, small, expected changes in the discount rate don't really worry me.


- The Economist