The Federal Reserve has just raised the interest rate on its discount window, an emergency lending facility used by banks, by 25 basis points, from ½% to ¾%, and shortened the term of the loans from 28 days to 24 hours. (The 28 days bit was an emergency measure, so the overnight duration is the pre-meltdown status quo)

This facility is used for short term lending, but it’s not frequently used, as generally, for overnight liquidity, etc., banks use the Federal Funds Rate, which dictates what rate banks use when they lend to each other.

The increase is on the difference between the discount window and the Federal Funds Rate. The discount window is more expensive, because its use is discouraged, the Fed prefers banks to deal in commercial money, not government money.

The Fed is saying that this does not represent a change in policy, and this is a small part of of the monetary picture, to be sure, but it is a tightening, and actions, as the saying goes, speak louder than words.

My guess, and my Federal Reserve Kremlinology is by no means authoritative, is that now that Bernanke has been safely confirmed by the Senate, he is looking toward creating an environment in which monetary policy can work.

Monetary policy, at least on the expansionary side of the equation, work now, because interest rates are below 1% and you can’t cut interest rates below 0%, at least not under the current regulatory environment.^*

It’s called the “Zero Bound” problem, and I’m sure that Bernanke, as well as the whole Fed, wants to be back in a world where inflation and employment can be managed in both directions though monetary tools.

Krugman actually wants this too, he’s been clear on this.

I just think that this move is somewhat premature.

The full statement is after the break.

^*Actually, you can, with inflation devaluing currency, as I have said many times, but raising inflation targets gives central bankers the hives.

Press Release
Federal Reserve Press Release

Release Date: February 18, 2010
For release at 4:30 p.m. EDT

The Federal Reserve Board on Thursday announced that in light of continued improvement in financial market conditions it had unanimously approved several modifications to the terms of its discount window lending programs.

Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve’s lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC). At that meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The changes to the discount window facilities include Board approval of requests by the boards of directors of the 12 Federal Reserve Banks to increase the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.

In addition, the Board announced that, effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight. Primary credit is provided by Reserve Banks on a fully secured basis to depository institutions that are in generally sound condition as a backup source of funds. Finally, the Board announced that it had raised the minimum bid rate for the Term Auction Facility (TAF) by 1/4 percentage point to 1/2 percent. The final TAF auction will be on March 8, 2010.

Easing the terms of primary credit was one of the Federal Reserve’s first responses to the financial crisis. On August 17, 2007, the Federal Reserve reduced the spread of the primary credit rate over the FOMC’s target for the federal funds rate to 1/2 percentage point, from 1 percentage point, and lengthened the typical maximum maturity from overnight to 30 days. On December 12, 2007, the Federal Reserve created the TAF to further improve the access of depository institutions to term funding. On March 16, 2008, the Federal Reserve lowered the spread of the primary credit rate over the target federal funds rate to 1/4 percentage point and extended the maximum maturity of primary credit loans to 90 days.

Subsequently, in response to improving conditions in wholesale funding markets, on June 25, 2009, the Federal Reserve initiated a gradual reduction in TAF auction sizes. As announced on November 17, 2009, and implemented on January 14, 2010, the Federal Reserve began the process of normalizing the terms on primary credit by reducing the typical maximum maturity to 28 days.

The increase in the discount rate announced Thursday widens the spread between the primary credit rate and the top of the FOMC’s 0 to 1/4 percent target range for the federal funds rate to 1/2 percentage point. The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve’s primary credit facility only as a backup source of funds. The Federal Reserve will assess over time whether further increases in the spread are appropriate in view of experience with the 1/2 percentage point spread.
2010 Monetary Policy Releases

Last update: February 18, 2010