Fed Raises Discount Rate And Minimum TAF Auction Rate

In a late-afternoon announcement, the Federal Reserve said Thursday that it was raising the discount rate from 0.50% to 0.75%. That's the rate at which it charges banks for emergency borrowing. It also raised the minimum bid for Term Auction Facility (TAF) auctions. It is, however, leaving the ever-important federal funds rate at its exceptionally low level of between 0% and 0.25% for an "extended period." These actions mark new steps in the Fed's exit strategy: now that the crisis is over, it's time to wean banks off borrowing from its balance sheet. I've got a few observations.

First: well, that was quick. It was only last week Bernanke wrote that the Fed would be raising the discount rate "before long" in a prepared speech. He was supposed to say this before the House Financial Service Committee, but the snow preempted the meeting. Now it's pretty easy to understand why he decided to release the speech anyway: he didn't want to catch anyone off guard. The meeting hasn't been rescheduled.

The discount rate increase should have little immediate impact, since not many banks are borrowing from the discount window. Even those who need emergency funding have instead generally chosen to participate in the TAF since its creation. But that's ending in March, and the Fed statement also increased the minimum bid in TAF auctions from 0.25% to 0.5%. That means that banks are being discouraged from borrowing emergency funds from the Fed, whether through the TAF or the discount window.

So while the move isn't terribly significant in the short-term, it does show just how serious the Fed is about reducing banks' dependence on its lending. This won't actually soak up any monetary supply already out there, but it will discourage banks from borrowing more.