Bernanke Says Federal Reserve May Raise Discount Rate Before Long

In testimony to the House Financial Services Panel today, Fed Chairman Bernanke said that the Fed may elect to raise the Fed Discount Rate before long. He was careful to say that this is part of a normalization in Fed lending as opposed to a change in monetary outlook. In other words, it changes the way the Fed supports banks but does not change their view on interest rates.

He repeated to the committee that low rates are warranted for an extended period of time and also said that the Fed is considering replacing the Fed Funds Rate, at least temporarily as a policy guide. Instead, the Fed would use the interest it pays on bank deposits at the Fed as the policy metric.

Discount Rate Versus the Federal Funds Rate

The discount rate is the rate at which banks can borrow money, usually overnight, from the Fed in order to meet their capital and deposit requirements. The Federal Funds Rate on the other hand, is the rate at which banks can borrow from one another via the Fed. The Discount Rate is usually higher than the Fed Funds Rate and is tapped by banks as a last resort. It is not as influential as the Fed Funds rate in impacting short term deposit and bond rates.

Before 2007, the spread between the Fed Funds Rate and the Discount Rate was 1 percentage point. During the financial crisis, that dropped to .50 percent, where it stands today. Both Goldman Sachs and Morgan Stanley converted to bank holding companies in order to gain access to this discount window.

Bernanke's remarks can be taken as a sign that the banking system has stabilized and no longer needs access to inexpensive emergency funds. Bernanke went out of his way to say that it is not a sign that the economy is roaring back and it's time to increase broader rates. The changes “are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC,” Bernanke said.

Still, the Fed may be only months away from tightening credit. U.S. central bankers will begin raising rates in November and increase the benchmark lending rate to 0.75 percent by the end of the year, according to the median estimate of economists surveyed by Bloomberg News in January. No matter how you look at it, the Fed it talking about raising a rate, and that is some positive news for long suffering savers.