Merriam-Webster defines “discount” as “a deduction from the usual cost of something, typically given for prompt or advance payment or to a special category of buyers.”
The Federal Reserve’s “discount rate” is the interest rate charged to commercial banks (yes, they’re special) and other depository institutions on loans they receive from their regional Fed bank's discount window.
By Dave Allen for Discount Gold & Silver
Merriam-Webster defines “discount” as “a deduction from the usual cost of something, typically given for prompt or advance payment or to a special category of buyers.”
The Federal Reserve’s “discount rate” is the interest rate charged to commercial banks (yes, they’re special) and other depository institutions on loans they receive from their regional Fed bank's discount window.
Banks whose reserves dip below the reserve requirement set by the Fed's board of governors use that money to correct the shortage.
The board of directors of each Fed bank sets the discount rate every two weeks (the rate is the same across the country).
It's considered the last resort for banks, which usually borrow from each other (at the Fed Funds rate).
The Fed uses the discount rate to control the supply of available funds, which in turn influences inflation and overall interest rates. The higher the money supply, the higher inflation tends to go (see chart).
Raising the discount rate makes it more expensive to borrow from the Fed. That lowers the supply of available money, which increases short-term interest rates.
Lowering the rate has the opposite effect, bringing short-term interest rates down.
The current primary discount rate is 0.25%. The secondary credit rate is a higher rate that's charged to banks that don't meet the requirements needed to achieve the primary rate; it's 0.75%.
Why is this relevant? Because the Fed governors often raise the discount rate ahead of Federal Open Market Committee hikes to its Fed Funds rate.
So, we’re keeping a close eye on the Board of Governors in the coming weeks to see if (i.e., when) they make a move, presumably ahead of the FOMC’s next meeting on March 15-16.
March Rate Hike A Near Certainty
As I’ve been writing, a bleak inflation trend has touched off a range of opinions from the Fed’s policymakers about just how fast they should raise interest rates beginning at their next meeting in March.
Wall Street estimates now range from a single rate increase — in March — to as many as 7 hikes — in 2022 alone!
St. Louis Fed prez James Bullard has renewed his call for the Fed to take the aggressive step of raising its benchmark Fed Funds rate by a full percentage point by July 1 — to an upper range of 1.25%.
KC Fed head Esther George supports a more “gradual” approach. And Prez Mary Daly of the San Fran Fed committed herself to nothing more than a modest rate hike next month.
Their comments follow last week’s report that inflation jumped 7.5% last month, the biggest increase in four decades.
As I wrote in last Friday’s blog, prices rose 0.6% from December to January, the same as the previous month, and down from 0.9% in October — suggesting that price gains may be moderating somewhat (although 0.6% x 12 months = annualized rate of 7.2% — still unacceptably high).
We know the Fed typically responds to high inflation by making borrowing for its poor bank constituents — and all Americans — more expensive.
That is intended to slow spending and price increases (but sometimes throws the economy into recession — i.e., and many more people out of work).
Last week’s government inflation report prompted a sharp increase in expectations for rate increases by the Fed this year.
Some economists now forecast as many as six or seven quarter-point hikes (for a total of 1.75 percentage points). That’s much higher than the Fed’s intimations in December of just three rate increases for 2022.
Bullard and Thomas Barkin, head of the Richmond Fed, are noting how the acceleration of prices has broadened beyond vehicles and other pandemic-affected industries.
Policymakers Agree on Little Else
Still, the two policymakers expressed differing views of how the Fed should respond.
“Inflation is very high,” Barkin said. “And the more recent readings suggest it’s broader and more persistent. I think it’s timely to get started and steadily move back toward pre-pandemic levels.”
Whoa, Tommy! Rates peaked at 2.45% in April 2019. That would mean as many as 9 quarter-percent increases. I guess the pundit projections aren’t hyperbole after all.
Barkin’s use of the term “steadily” suggests that he favors moving at a more measured pace than Bullard, who recently said that the Fed might even decide to raise rates before its March meeting.
Yesterday, Bullard said “inflation is broadening and possibly accelerating.” And he stood by his call for a full percentage point increase in the Fed’s key rate by July 1st.
An increase that large would mean rate hikes at the Fed’s March, May, and June meetings, with one of those hikes amounting to a half-point (unless the Fed decides to take down stock markets with an initial 1.0% increase).
Bullard noted, “We need to front-load more” of the rate increases. We’ve been surprised to the upside on inflation. Our credibility is on the line here.”
Ah, yes, credibility — the Fed’s third, unwritten mandate, besides seeking stable prices and maximum employment (whatever that is).
No other Fed officials have publicly called for a half-point rate hike at an upcoming meeting, though yesterday investors were pricing in a 60% probability of such a step in March.
On Sunday, Daly said that an increase that large could hurt the economy (she probably meant the stock markets) by potentially slowing spending too quickly:
“History tells us Fed policy that abrupt and aggressive...can actually have a destabilizing effect on the very growth and price stability we’re trying to achieve.”
She expressed support for a rate hike in March but didn’t back Barkin’s call for ongoing increases, saying data should drive future decisions:
“I see March as an appropriate time to raise the interest rate, and then we have to take in all of the information ... and make the right decision at the right time for the economy.”
Last Friday, George weighed in on another option being considered by the Fed. She said that the Fed should consider selling some of the government securities that make up its nearly $9 trillion balance sheet.
The Fed said last month that it would reduce the size of its balance sheet by letting its investments mature and not reinvesting the proceeds.
Some economists fear, however, that going beyond that and actually selling some of those Treasuries and mortgage-backed securities would likely send longer-term interest rates higher.
Fed Chair Jerome Powell has been quiet since the most recent jobs and inflation reports have shown stronger hiring and wage growth along with rapid price gains.
Powell appears to be waiting for Senate confirmation for a second 4-year term.
Lael Brainard, another current Fed board member who has been nominated for the vice chair position, is also awaiting a Senate vote.
The Senate Banking Committee was scheduled to vote on their nominations today, as this article was going to press, along with Biden’s other nominees, Sarah Bloom Raskin, Lisa Cook and Philip Jefferson.