Magazine article Economic Trends

Monetary Policy

Magazine article Economic Trends

Monetary Policy

Article excerpt

As of January 9, 2003, instead of the discount rate, Federal Reserve Banks began to offer depository institutions two discount window programs: primary credit and secondary credit. Primary credit loans are extended for a very short term (usually overnight) to depository institutions in generally sound financial condition. This rate (currently 2.25%) will initially be 100 basis points (bp) above the target federal funds rate set by the Federal Open Market Committee (FOMC). Depository institutions not eligible for primary credit may apply for secondary credit, which will initially be set 50 bp above the primary credit rate.

At its January 28-29 meeting, the FOMC left the intended federal funds rate unchanged at 1.25%. As of January 24, the federal funds futures' June contract traded at 1.12%, 13 bp below the current federal funds rate target, suggesting that market participants are betting the next change will be down.

Long-term rates respond to changes in inflationary expectations. Since last July, the yield curve has shifted down at both the short and the long end. Long-term rates are an average of current and implied future short-term rates. Implied forward rates have fallen since July, suggesting that long-term inflationary expectations have dropped. Since December, long-term rates have fallen and short-term rates have been essentially unchanged. Both long-term and implied forward rates suggest that long-term inflationary expectations continue to fall.

Another way to gauge long-term inflation expectations is by subtracting the yield on 10-year Treasury inflation-indexed securities (TIIS), a signal of the real rate of interest, from the 10-year Treasury bill. …

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