Question

Of the major tools of monetary policy why does the Fed so rarely use the discount rate to implement monetary policy?

Describe the difference between a regional bank and a money center bank.

Answer 1

There are threeFederal Reserve's instruments of monetary policy are 1.open market operations, 2.discount rate and 3.reserve requirements.

Open market operations are the buying and selling of government securities in the market. It is commonly used monetary policy.The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans.Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.

Federal Reserve rarely uses the discount rate as a monetary policy tool. First, it is difficult for the Fed to predict changes in bank discount window borrowing when the discount rate changes. There is no guarantee that FIs will borrow more (less at the discount window in response to a decrease (increase) in the discount rate.Thus, the effect of a discount rate change on the money supply is often uncertain or unpredictable, which increases the chance of missing the target change in the money supply. Second, in addition to their effect on the moneysupply, discount rate changes often have great effects on the financial markets.

Regional banking is a depository institution (DI), i.e. a bank, savings and loan, or credit union, which is larger than a community bank, which operates below the state level, but smaller than a money center bank, which operates either nationally or internationally. It  utilize retail deposit bases for funding, but also develop relationships with large corporate customers.

A money centre banks are similar to standard bank. This instution mostly deal with  borrowing, and lending activities with governments, large corporations, and regular banks. These types of financial institutions do not borrow from or lend to consumers.

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