The attractive margins on commercial lending (a gaping three-point spread between the prime rate and the Federal Reserve discount rate) don't alter this gloomy picture.
We now expect a 25-basis-point cut in the Federal funds rate and discount rate on Dec. 11.
But meanwhile, the Federal Reserve has cut the discount rate three percentage points since last September, and may lower it to two percent this week.
If QE2 succeeds, interest rates will eventually increase as the Federal Reserve will raise the discount rate to ensure economic growth and the likely resulting inflation does not overshoot its targets.
When the Fed reduced the discount rate in September 2007 and left the Federal Funds rate unchanged, it was deliberately increasing the likelihood that banks would shift their borrowing to the Fed and trigger reserve and monetary expansion.
In the years immediately preceding the latest financial crisis, the Fed worked to restore the discount rate as a penalty rate somewhat higher than the Federal Funds rate.
The Fed even narrowed the penalty banks paid for using discount window money, moving the discount rate closer to the Federal funds rate during the crisis.
The Fed would use the discount rate rather than the federal funds market to supply or withdraw credit in response to any imbalance between supply and demand for it.
The current discount rate, 3.5%, is significantly higher than the 3% federal funds rate, which is what banks charge each other.
However, during unusual periods of reserve shortages in the banking system, the Federal Funds rate would be bid up above the discount rate and trigger borrowing from the Fed.
Hence, the Fed entered the crisis with the Federal Funds target rate at 5.25 percent and the discount rate at 6.25 percent.
Unless the Fed has changed its mind about one percentage point being the desired spread in normal times, the discount rate will be raised again relative to the Federal Funds rate.
It used to be considered bad form to have to tap the Fed's discount window, where rates are about one point over the federal funds rate, or 6.25%.
The markets are broadly anticipating that the Federal Reserve will lower the fed funds rate, as well as the discount rate, by 25 basis points later this afternoon, and there is little reason to think Wednesday's GDP figure will change that.
The discount rate is the rate that banks use to borrow from the Federal Reserve.
If you consider the present Federal Funds rate to be a quarter of a percentage point, the preferred discount rate will be one and a quarter percentage points.
Having the discount rate higher meant that, in normal times, borrowing in the Federal Funds market would be less expensive than borrowing from the Fed.
The logic of a penalty discount rate is that the Fed prefers to let the rate structure ration Federal Reserve credit rather than having to do so administratively.
The Federal Reserve said Friday it has approved a half-percentage point cut in the discount rate - a dramatic move aimed at calming markets roiled by a widening credit crisis.
The Federal Reserve, lagging other central banks, pumped in extra money and then cut its discount rate to prevent a seizure of the financial system in the aftermath of the subprime mortgage market debacle.
In fact, the Fed was established as a result of the Panic of 1907 and the discount mechanism and rate were the only tools of monetary policy given to the Fed in the Federal Reserve Act.
The Federal Reserve is preparing to narrow this spread, first by raising the rate it charges on loans through its discount window.
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