I’m sure a lot of you have heard that the feds just slashed the discount rate. If i’m correct, some of the effects will include market growth at the expense of higher inflation as more money will flow into the economy. My questions might seem too basic but i’ll go ahead and ask. My first question is; Could the feds have cut rates (indirectly) through buying treasury bonds in open market operations? and if so, are the effects of this action the same as cutting the discount rate? I also heard in the media that cutting rates traditionally leads to higher prices in oil. Is that simply because of the inflation rate going up? Thanks in advance
kguizo Wrote: ------------------------------------------------------- > I’m sure a lot of you have heard that the feds > just slashed the discount rate. If i’m correct, > some of the effects will include market growth at > the expense of higher inflation as more money will > flow into the economy. My questions might seem too > basic but i’ll go ahead and ask. My first question > is; Could the feds have cut rates (indirectly) > through buying treasury bonds in open market > operations? and if so, are the effects of this > action the same as cutting the discount rate? > > I also heard in the media that cutting rates > traditionally leads to higher prices in oil. Is > that simply because of the inflation rate going > up? > Thanks in advance The Fed doesn’t really buy bonds in open market operations, they repo them. However, if the Fed wanted to go out and buy bonds by bidding them up and thus driving down yields I would happily retire on my own island by playing the Fed action as would half of Connecticut. In the end, it would just put lots of money in the hands of bond traders and not have the effect they want. Normal open market operations do not have nearly as clear an effect on bond prices as the Fed is just providing financing not competing for bonds. Lowering the discount rate has this enormous symbolic effect that is pretty profound. Not much money is actually borrowed at the discount window but it ripples through interest rates that do matter. This monetary response to a fiscal and credit liquidity problem is just odd and it’s even odder that everyone called a bottom on an expected Fed action.
It’s my understanding that the rate decrease will further increase the money supply thus increasing inflation and further decreasing the overall value of the dollar compared with other currencies. This usually makes the commodity market (including crude more attractive) driving up prices. Not sure how much it will help. Banks will make out better for sure, but I believe they’ll still have tightened lending policies so it’s unclear how much of that discount will make into our pockets in the form of lower mortgage and loan rates. Should help somewhat on credit card balances, but will drive down interest bearing accounts such as cd’s and savings accounts. *shrug*
Shabadoo1 Wrote: ------------------------------------------------------- >… it’s unclear > how much of that discount will make into our > pockets in the form of lower mortgage and loan > rates. Should help somewhat on credit card > balances, but will drive down interest bearing > accounts such as cd’s and savings accounts. That is true, it will affect the interest rates Mr. Joe Blow pays on his credit cards and home equity line of credit, resulting in a little more in his pocket to waste at other useless stuff that he doesn’t really need. This results in adding more to his outstanding debt and at the same time lowering the interest Mr. Blow would earn on his savings, which he normally doesn’t have. On the macro level the rate cut resulted in Lehman borrowing a small amount from the Fed’s discount window, and Goldman is expected to do the same (other banks are likely to follow). This would result in relaxing the liquidity concerns for these firms and restore some investor confidence.
It should be noted that the Board of Governors cut the discount rate but the FOMC also cut the targeted federal funds rate. Both cuts were for 75 basis points. When the fed reduces aka cuts the targeted federal funds rate it implements this change through open market operations aka increasing the money supply. When the fed cuts the discount rate it simply cuts the price at which it offers short term funds at the discount window. The discount rate is the interest rate at which the Fed lends short-term money to banks, while the federal funds rate is the rate at which banks lend short-term money to eachother. They can have the same effect. Currently the Discount Rate is 2.5 and the Targeted Federal Funds Rate is 2.25. My understanding is that the Fed encourages banks to borrow amongst themselves first before utilizing the Discount Window. Furthermore banks prefer to borrow amongst themselves given the stigma that is attached to borrowing at the Discount Window. The stigma being that other banks think the borrowing bank is too risky to lend to thus it has no choice but to borrow from the Fed. Admittedly my understanding of this is very limited perhaps someone with more detailed knowledge of the Fed can chime in and correct me if I’m wrong.
JoeyDVivre Wrote: ------------------------------------------------------- > kguizo Wrote: > -------------------------------------------------- > ----- > > I’m sure a lot of you have heard that the feds > > just slashed the discount rate. If i’m correct, > > some of the effects will include market growth > at > > the expense of higher inflation as more money > will > > flow into the economy. My questions might seem > too > > basic but i’ll go ahead and ask. My first > question > > is; Could the feds have cut rates (indirectly) > > through buying treasury bonds in open market > > operations? and if so, are the effects of this > > action the same as cutting the discount rate? > > > > I also heard in the media that cutting rates > > traditionally leads to higher prices in oil. Is > > that simply because of the inflation rate going > > up? > > Thanks in advance > > > The Fed doesn’t really buy bonds in open market > operations, they repo them. However, if the Fed > wanted to go out and buy bonds by bidding them up > and thus driving down yields I would happily > retire on my own island by playing the Fed action > as would half of Connecticut. In the end, it > would just put lots of money in the hands of bond > traders and not have the effect they want. Normal > open market operations do not have nearly as clear > an effect on bond prices as the Fed is just > providing financing not competing for bonds. > > Lowering the discount rate has this enormous > symbolic effect that is pretty profound. Not much > money is actually borrowed at the discount window > but it ripples through interest rates that do > matter. > > This monetary response to a fiscal and credit > liquidity problem is just odd and it’s even odder > that everyone called a bottom on an expected Fed > action. Thank you for your response JoeyDVivre. My understanding on the subject was that when the Fed repossess the bonds, they inject money into the economy thereby increasing the inflation rate, and since Nominal Interest rate = Real interest rate + Expected Inflation Rate, this action of the fed would raise most market interest rates (there are so many rates), ceteris paribus. On the other hand, I was thinking that the action of the fed selling treasury bonds would reduce the money supply and therefore reduce inflation ==> lower market interest rates. Is there anything wrong with this reasoning. Thanks,
Shabadoo1 Wrote: ------------------------------------------------------- > It’s my understanding that the rate decrease will > further increase the money supply thus increasing > inflation and further decreasing the overall value > of the dollar compared with other currencies. > This usually makes the commodity market (including > crude more attractive) driving up prices. > > > *shrug* Thank you Shabadoo1 for this comment. This answers my last question
Anyone else wanna add anything to this? The Fed repo bonds ==> higher inflation ==> higher interest rates The Fed sell T bonds ==> lower inflation ==> lower interest rates is this relationship correct or am i missing something? I’m using fisher’s formula here Thanks,