Federal Reserve: understanding changes in the discount rate

Via Williams Shughart at the Independent Institute:
It is ludicrous to characterize the discount rate as the interest rate that penalizes banks for having to apply for “emergency” loans from the central bank. If it is to serve that purpose, as I learned at the knees of Tom Saving and Phil Gramm, the discount rate must closely approximate the market interest rate. Banks otherwise will have incentive to borrow funds from the Fed and then relend them at a profit. Given that market interest rates on mortgages and other secured consumer loans currently are running at five or six percent per year, it makes only a small difference in profitability if lenders can borrow from the Fed at three-quarters rather than one-half of one percent.

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