Hey guys, I have a couple questions about monetary policy. First a little bit more broad. The book describes the discount rate as one of the Fed’s monetary policy instruemnts. The fed changes the discount rate by controlling the supply and demand of money? Or is that how they set the Fed Funds rate. Basically what is the difference between how the fed sets the discount and fed funds rate. And also can someone brieflyt explain the difference in the McCallum and Taylor rules. I interperet them as being different in how they reach their goals (stabilizing the price level) Thanks for any help. - Eric
The discount rate and fed funds rate are synonymous and currently at 2%. The discount window rate is 25 basis points over fed funds. The prime rate is 300 bps over fed funds. The rate is set at the FOMC meetings which happen every so often. Here is the statement following yesterday’s meeting: http://www.federalreserve.gov/newsevents/press/monetary/20080805a.htm
“The discount rate and fed funds rate are synonymous and currently at 2%” Yikes! Completely not true. The discount rate is the rate at which banks can borrow from the Fed. The Fed sets it and banks who borrow at the discount window get it. There is no supply and demand and theoretically they could set it wherever they want. The Fed Funds rate is the rate at which banks lend to other banks. It is market driven and not directly controlled by the Fed. The Fed however sets a Fed Funds Target rate and conducts open market operations aimed at keeping the FF rate near the FF target rate.
Always remember: For CFA purposes, the fed’s most used method is open market operations. 2nd most used is changing the discount rate, and last is the required reserves ratio. Therefore, for CFA purposes, the fed fund rate is technically not a monetary policy tool. The above 3 tools are used to achieve the targeted fed funds rate. The fund rate is the end goal. the problem with the news is that they never explain this. All anyone knows is that the rate has changed. nobody knows much about the rate.
escioffi Wrote: ------------------------------------------------------- > > And also can someone brieflyt explain the > difference in the McCallum and Taylor rules. I > interperet them as being different in how they > reach their goals (stabilizing the price level) > Also, I’m sure this is in your books better than I can give it to you but: a) Taylor also cares about keeping GDP healthy while McCallum just cares about price stability b) Taylor is immediately responsive to business cycle changes and McCallum isn’t c) Taylor’s instrument is the central banks target rate for Fed Funds. McCallum’s instrument is the money supply directly.