The Discount Rate: The Other Tool of Monetary Policy

by Stephen K. McNees
July/August 1993

Although open market operations are clearly the primary monetary policy tool, the discount rate is not without influence. Federal Reserve Banks propose any discount rate changes, and the Board of Governors decides whether to accept, reject, or take no action on their requests. This article examines the involvement and influence of the various Reserve Banks in this process, exploring their participation over a 20-year period. The historical analysis shows that Reserve Banks differ in the frequency, persistence, and direction of their proposals for change.

The article also develops statistical models for the decision procedures of the Reserve Banks in proposing a change and for the Board’s rulings on those proposals. Both pay particular attention to labor markets, financial markets, and inflation or monetary aggregates. Results also show that the number of Reserve Bank proposals before the Board does play an independent role in the Board’s decisions, above and beyond national economic conditions.

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