Kathleen Stephansen from Credit Suisse:
Just thank you very much for this very interesting speech. Just a question: You alluded to the discount rate and the stigma that it still carries. Would you think that if there was no spread between the discount rate and the Fed funds rate, whether that stigma would disappear?

Kohn from the fed:
I think if there were no spread, the economic incentives might overcome the stigma. I’m not sure that the stigma would entirely disappear.

Agreed.

But I think part of what we’re seeing — if I can sort of reframe your question — about the lack of use of the discount window is partly economic and partly non-economic or partly about the 50 basis points, but partly about the stigma. And obviously, if we take the 50 basis points away and you can simply borrow at the federal funds rate, in effect I think the funding market would come all into the Federal Reserve. I mean, everyone would be borrowing a lot, including people who don’t — it’s a very — it would be a very difficult thing to do.

Perhaps true, but not a ‘bad’ thing where the fed would be ‘broker of last resort’.

The question is, what is the further purpose of not doing it that way? What is gained by banks settling clearing residuals with each other rather than with the fed?

Net lending from the fed would be unchanged, as banks strive to minimize reserve balances in either case.

Real resources would be saved, as banks would not need to spend the time and effort trying to trade with each other.

The NY fed would have full control over the fed funds rate as it could keep the system modestly ‘net borrowed’ with open market operations as it did pre 2003.

The only possible value of the current arrangement would be if the employed market forces as a discipline on bank funding. But it doesn’t, so there is no advantage for the current set up that I can see.

There are people who don’t borrow at the federal funds rate, right — smaller, medium-sized banks. And if they saw this window, they would come in and borrow — basically, we would be giving them funds at a subsidized rate that people don’t ordinarily have access at the funds rate.

Point? Why should money center banks have access to cheaper funds than regional member banks? All carry the same deposit insurance, and smaller banks have higher percentages of insured deposits.

Doesn’t the fed desire the fed funds rate to be the universal cost of bank funds? If not, that can be addressed in other ways.

And we would be creating, I think, problems for the open markets, because they would have to anticipate how many reserves are going to be supplied through the discount window, which would be very hard to anticipate, and then drain those through open-market operations.

No, the NY fed would instead find its job far easier. Just keep banks net borrowed in any quantity. And if they over do it with excessive liquidity drains, it will only show up as increased window borrowings, not as a deviation of the fed funds rate from the target rate.

That’s not to say that circumstances might not dictate at some point that we do something more with that penalty. I don’t want to take that off the table. I think it’s fair to say — as I kind of hinted at in my little section on liquidity — that we’re looking at lots of different options about how to supply liquidity to the market. But I think we need to recognize that the one you came up with has some costs and some difficulties associated with it.

I see a reduction in costs and a reduction in the difficulties surrounding current policy.

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