What does the Fed's discount rate increase mean?

By , Guest blogger

  • close
    Federal Reserve Chairman Ben Bernanke (shown here awaiting to testify last year at a Senate committee hearing) raised the central bank's discount rate Feb. 18.
    View Caption

So the Fed unexpectedly decided to raise the discount rate. What implications will this have?

The direct effect is neglible. The discount window is used so rarely that a discount rate increase won't have any effect on real world interest rates worth mentioning.

However, as the market reaction illustrates, this increase will have the indirect effect of increasing expectations that the Fed will increase the rates that really matter – the Fed funds rate and the interest that the Fed pays on bank reserves – sooner rather than later.

Recommended: Could you pass a US citizenship test?

While the Fed claims that this is meant to normalize the spread between the funds rate and the discount rate, and that they intend to keep the funds rate low for an extended period, and while this may actually be true, many people will nevertheless interpret this as a signal that the more important rates will be raised sooner than people earlier thought, something which will increase bond yields, and thus have a tightening/deflationary effect. The effect will however probably only be very small.

Add/view comments on this post.

-----------------------

The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the blogger's own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.

Share this story:

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...