May 19, 2012. Paul Hixon
The discount rate is the rate of interest that financial institutions must pay to bar reserve deposits from the Fed. When the discount rate is low, financial stations have an inexpensive source of funds for reserve requirement obligations, provided they don’t mind the “discount window scrutiny.”
That is, banks that frequently borrow from the discount window signal that they may have serious financial problems since they are not able to obtain funds in the market. For this reason, when the discount rate is low, financial institutions will prudently expand their assets and deposits more readily, because it will not cost them as much to obtain the reserves acquired to back their new deposit or asset holdings. When the discount rate is high, the institutions are more reluctant to borrow reserves and are therefore more careful about expanding assets and deposits holdings if they must borrow from the Fed.
When banks grow from the discount window of the funds they borrow are paid in reserves by the Fed. Mosques, when banks borrow at the discount window, there is an increase in reserves in the banking system and an increase in the money supply. The bank can hold the reserves if it is short of required reserves. It can make loans to businesses or consumers or it can lend a reserves to other banks in the federal funds market. Similar reasoning suggests that when banks pay back loans at the discount window, the payment is made in reserves and decreasing reserves in the banking system which results in a corresponding decline in the money supply. As you can see the Federal Reserve holds absolute power over any financial institution in the United States. Especially considering that the chairman is for all intents and purposes a financial dictator, it is almost scary to ask who has more power, the Chairman of the Federal Reserve or the President of the United States?
If you liked this financial topic then, you may be interested in how to read stock chart signal and how to read forex charts.
Updated May 19, 2012. Published January 19, 2011. Paul Hixon
