Posted: March 30th, 2022
he Tools used by the Federal Reserve Bank to Maintain Monetary Policy Goals
• The Federal Reserve Bank utilizes tools such as the discount rate, open market operations, interest on reserves and reserve requirements to control money circulation in the banking system.
• The interest rate imposed on banks by the Federal Reserve is called the federal discount rate.
• The Fed’s Board of Governors sets the discount rate to adjust money circulation in the baking system.
• Using monetary policy tools, the Fed solves economic issues such as inflation, unemployment, prices, and availability of loans from banks.
• When the economy has an excess supply of money, the purchasing value of money decreases, leading to inflation.
• Lending at the discount rate is one of the Fed’s primary monetary policy tools and is part of the Fed’s function as a lender of last resort
• The Fed is also called a standing lending facility because it allows banks to borrow all
they want at very short maturities to prevent undue bank failures.
• Banks facing increased liquidity needs or heightened risks can sometimes not raise the necessary funds in the open market.
• Fed discount lending serves as an emergency back up to give liquidity to the commercial banks in order to prevent them from failing once their interbank overnight lending system has been maxed out,
• The interbank rate, which is usually lower than the discount rate, is called the Fed funds rate.
• Banks opts to borrow from
other banks when the fund’s rate charges by the Fed is lower than the discount rate
• Therefore, the total amount of discount lending is minimal and intended only to be a backup source of liquidity for sound banks.
• discount lending is generally classified as either secondary or primary credit.
• The Fed also provide seasonal loans to banks which offer seasonal loans to the community, such as agricultural loans
• Depository institutions and commercial banks in generally sound financial conditions are eligible to borrow from their regional Fed banks at a primary credit rate called the discount rate.
• Funds that are borrowed by the banks from the federal reserve are processed through the discount window, and the rate is reviewed every two weeks.
• Secondary credit is provided by the federal reserve to commercial banks that are experiencing severe liquidity and financial problems.
• the central bank’s interest rate on secondary credit is usually set at 0.5 percentage points above the discount rate.
• The interest rate on these loans is set at a higher penalty rate to reflect the less-sound condition of the borrowers.
• Beyond its role in preventing bank failures, the federal discount rate is used as a tool to either stimulate or rein in the economy.
• A decrease in the discount rate makes it cheaper for commercial banks to borrow money, which results in an increase in available credit and lending activity throughout the economy.
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