Which is better suited to deal with a credit crunch-the discount rate or the Fed-funds rate?
Normally, the discount rate is better for a couple of reasons. Borrowing at the discount window is done at the initiative of the borrowing bank; so the funds are more likely to go where needed. And, unless offset with open market operations, the new reserves to the borrowing banks will also represent an expansion of reserves to the banking system as a whole. When banks get reserves from other banks in the Fed-funds market, they are just swapping around existing reserves. Reserves gained by some banks will be lost to other banks. Cutting the target Fed-funds rate is a more general, less focused, action. It will stimulate the economy as a whole, and may be needed, but the impact on what’s causing the credit crunch will not be very direct. Was the Fed’s reduction in the discount rate a good idea? Yes, it was an excellent idea. However, as it turned out, it led to very little borrowing. This tells me that the problem wasn’t one of liquidity where firms needed to convert sound, but illiquid
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