A Bargain for Borrowers: Policy Split on Rates Creates Cheap Money
Over the past year, a disagreement among Federal Reserve policymakers has caused the central bank to lend money to financial institutions at bargain interest rates, cost-inn the novernment millions of dollars and contributing at least a small new headache to the management of monetary policy.</br></br>The amount of the savings garnered by financial institutions borrowing from the Fed is hard to calculate, but it was at least $10 million and probably was several times that.</br></br>However, for reasons that are far from clear, banks and other financial institutions have not rushed to snap up the cheap money by borrowing at the Fed discount window. Fed officials speculate that the institutions fear that such borrowing, particularly by large banks, could be seen as a sign they were in serious financial difficulty.</br></br>Beginning in April 1988, when the Fed began to boost short-term interest rates to slow economic growth and control inflation, it did not increase its discount rate, the interest rate it charges on loans to financial institutions. Instead, the tighter Fed policy showed up entirely in increases in the federal funds rate, the rate institutions charge when they loan reservesÛÓcashÛÓto one another.</br></br>Normally, the Fed keeps the federal funds rate roughly half a percentage point or so higher than the discount rate. Even thougli the discount rate was raised from 6 percent to 6.5 percent in August and to 7 percent in February, the spread between the two rates currently stands at about 2.8 percentage points. That means, for instance, that on much of the $2.3 billion bor-See DISCOUNT, lit, Col, 1 j rowed from the Fed last month, the ! discount rate was about 2,3 percent-j age points lower than "normal."