OK, no more Greenspan blogging, I hope. Instead – rate cut blogging!
Obviously I have no idea what the Fed will do this afternoon, or even really
what it should do. But my gut feeling is that Bernanke should announce a nominal
25bp cut in the Fed funds rate to 5% (hell, it
averaged 5% in August anyway) along with a more substantial 50bp or even
75bp cut in the discount rate. Greg Ip notes
today that "many on Wall Street feel the Fed has yet to make the discount
window attractive," especially given that the spread between the Fed funds
rate and the discount rate has been widening thanks to the lower-than-target
funds rate.
Justin Lahart, on the other hand, says it
might not be as easy as all that:
Many market participants expect a large discount-rate cut, but there is a
caveat that the Fed might find too large to ignore: If such a cut leads to
a substantial increase in borrowing at the discount window, the influx of
cash onto banks’ reserve balances could push the federal-funds rate well below
its target.
I’m not sure I understand. As I understand it, the Fed controls the Fed funds
rate through open-market mechanisms. In times of extreme volatility or illiquidity,
that control might not be perfect, but if the Fed wanted to raise rates right
now, it could. In principle, is there any reason why the discount rate can’t
be as low as – or even lower than – the Fed funds rate?