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The discount window : time for reform?

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  • Craig S. Hakkio
  • Gordon H. Sellon, Jr.

Abstract

For many years, the Federal Reserve's discount window has played an important role in monetary policy. Discount window borrowing helps individual depository institutions manage their reserve accounts in the presence of unexpected deposit and payments flows. Improved reserve management, in turn, helps stabilize the overnight federal funds market by reducing the volatility of short-term interest rates. Moreover, announced changes in the Federal Reserve's discount rate have often signaled important shifts in the stance of monetary policy and have frequently been associated with large changes in market interest rates, exchange rates, and asset prices.> In the 1990s, however, fewer and fewer institutions have relied on the window to meet short-term credit needs. Consequently, the usefulness of the discount window in smoothing reserve imbalances and stabilizing interest rates may have been reduced. In addition, changes in monetary policy operating procedures and the formal announcement of monetary policy decisions by the Federal Reserve may have reduced the effectiveness of discount rate changes in influencing market interest rates and asset prices.> Hakkio and Sellon analyze the changing role of the discount window in monetary policy and examine the case for discount window reform. One alternative to the traditional discount window is a "Lombard-type" lending facility in which depository institutions can borrow more freely than under the current system but at a higher rate. While there appear to be good arguments in favor of modernizing the discount mechanism, a number of conceptual and practical issues must be addressed before implementing a Lombard-type lending facility. An additional consideration, going forward, is the projected reduction in the supply of Treasury debt over the next few years. A shrinking supply of Treasury securities could complicate the use of open market operations in providing reserves to the banking system and require the Federal Reserve to place greater emphasis on the discount window. Consequently, any redesign of the discount window would need to address this issue.

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Bibliographic Info

Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

Volume (Year): (2000)
Issue (Month): Q II ()
Pages: 1-20

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Handle: RePEc:fip:fedker:y:2000:i:qii:p:1-20:n:v.85no.2

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Keywords: Discount window ; Discount ; Monetary policy;

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Cited by:
  1. Dieter Nautz & Jan Scheithauer, 2009. "Monetary Policy Implementation and Overnight Rate Persistence," SFB 649 Discussion Papers SFB649DP2009-053, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  2. M.M.G. Fase & W.F.V. Vanthoor, 2000. "The Federal Reserve System Discussed: A Comparative Analysis," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum, SUERF - The European Money and Finance Forum.
  3. Furfine, Craig, 2001. "The reluctance to borrow from the Fed," Economics Letters, Elsevier, Elsevier, vol. 72(2), pages 209-213, August.
  4. Kim, Iljoong & Kim, Inbae, 2007. "Endogenous selection of monetary institutions: With the case of discount windows and bureaucratic discretion," International Review of Law and Economics, Elsevier, Elsevier, vol. 27(3), pages 330-350, September.
  5. Ali Darrat & Khaled Elkhal & Gaurango Banerjee & Maosen Zhong, 2004. "Why do US banks borrow from the Fed? A fresh look at the 'reluctance' phenomenon," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 14(7), pages 477-484.

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