SOURCE: “The Economist”
The question was recently posed in ‘The Economist”; does the Fed’s recent interest rate cut mean a looser monetary policy? For those who missed it, the Fed lowered the discount interest rates from 6.25% to 5.75%. The discount rate is the rate at which banks can borrow from the Fed if they ever get in a pinch or bind. Designed in a way to discourage banks from using it, it’s more of an emergency measure. Banks are discouraged from borrowing money from the Fed because it’s an indicator that the bank cannot find another bank to borrow from, a possible red flag for insolvency. The discount rate is a whole point higher than the rate banks can usually borrow from each other.
With the current speculation in the market, the drop in the discount rates provides an easier way for banks to borrow and assure banks that the supply of money isn’t going away. Many analyze that the Fed will drop rates again in September and again in October.
The believed conclusion is: “The less charitable interpretation is that the central bank has softened the penalty for banks that have funded purchases of very illiquid assets with short-term paper. If it loosens policy while markets are only in the early stages of adjusting and before the economic risks are real, it will seem like a reward for banks and hedge funds that took on too much risk.”
Read the full report here >>
