Basic Techniques  |  OCT 1998

The Next Discount Rate Change by Steven M. Morris

Here's a review of the changes in the discount rate, and the implications for investors. The Federal Reserve Act of 1913, modified by the banking acts of 1933 and 1935, created the Federal Reserve System, the central bank of the United States. The responsibilities of the Fed, as it is commonly known, falls into four categories. The Fed supervises and regulates the banks to ensure the safety and financial soundness of the country’s banking system. It maintains the stability of the financial system and contains any systematic risk that may arise in the financial markets. It provides financial services to the US government, financial institutions, foreign official institutions and the public, including playing a major role in the foreign exchange markets. The Fed also conducts the nation’s monetary policy by effecting the money and credit conditions in the economy. That last responsibility is implemented in numerous ways. One way is to regulate the growth of the economy by adjusting the discount rate, which is the rate the Fed charges on its short-term loans to banks and other depository institu-tions in its role as lender of last resort. Increases in the discount rate can lead to a restrictive credit situation in the economy, and slow economic growth. On the other hand, lowering the discount rate will increase the available supply of credit and generally aid the growth rate of the economy.

by Steven M. Morris