Discount rate, fed funds rate

@Indian Investor:

Apropos your comment, off the top of my head, without doing any research (which needs to be done! point noted your honour), I would say the discount rate sets a ceiling to the tunnel in which the effective interest rate moves, the floor being set by the rate paid on reserves-the bank rate, as noted in the post below.  This is because, the discount rate is punitive.  It is a sign of opprobrium if a bank is “forced into the window”.  You can always get credit at the discount window, but you have to have first class collateral, and you have to pay a higher rate than you would on the fed funds market.

The market for fed funds is an interbank market.  It is the market for overnight lending between banks.  I still haven’t been able to find out if uncollateralised loans are made on the market, but if the main instrument for lending is the repo, these transactions are automatically collateralised.  So what could differentiate the discount rate from the fed funds rate is the list of collateral eligible, as well as the counterparty.  (Here note have to find out these lists of acceptable paper).  The discount rate has to be higher than the fed funds rate, otherwise a bank could borrow at the window and lend the funds on the fed funds market thus locking in an arbitrage profit, or making a “money machine”.  This discount rate spoken of heretofore is for primary credit from the Fed.  There are different rates for secondary credit and seasonal credit.

But as to your point about the fall in central bank purchases of US treasuries, I would like to know the source of your data.  Please provide link.  I am guessing it is either TIC data or  custodial holdings of foreign central banks issued by the Fed.  Even if I take your story as true, I am led to ask (forestalling your anticipation of an imminent collapse in the dollar) what are they going to diversify into, if they are moving out of US treasuries?  USTs remain the only safe haven for the cautious investor, the eurozone paper not looking all that great anymore.  And besides, a precipitous decline in the dollar would reduce the value of existing stocks of USTs held by the Japanese and Chinese central banks.  That would be a huge loss of wealth and it is in the interests of the Japanese and Chinese to see that there is no such collapse.  Thus the dollar looks pretty well poised for the next ten years at least.  Pardon me if I ramble.  And if I have been unfair in attributing to you an apocalyptic vision of the economic future, pardon me as well.


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