Federal Reserve to Consider Raising Discount Rate

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When the Federal Reserve's interest-rate soothsayers meet on Tuesday, they will face a number of issues in setting the discount rate that the central bank charges on loans to banks.

The Federal Reserve's Open Market Committee faces an economy with only muted growth projections for this year and into 2011, and a modest improvement in the employment outlook for the second quarter. Separately, the governors face the issue of their temporarily thinner ranks: The normally seven-member board of governors has two vacancies already, and this month brought an announcement from Fed Vice Chairman Donald Kohn that he will retire in June.

Last month, the Federal Reserve raised its discount rate to 0.75% from 0.50% -- marking its first rate hike since the economy went into a tailspin. The Federal Reserve is expected to issue a decision later this afternoon on whether to raise the discount rate again, and investors are wondering if lightening will strike twice.

In making its decision in February to raise the rates, the Federal Reserve stated: "...these changes are intended as a further normalization of the Federal Reserve's lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy."

And what is normal?

Some Federal Reserve Bank directors noted in January, prior to the hike in the discount rate, that they favored increasing the primary credit rate by 25 basis points as a move to begin to restore a more normal discount rate structure.

"The proposed increase would widen the spread between the primary credit rate and the upper end of the Federal Open Market Committee's target range for the federal funds rate to 50 basis points," according to minutes from the Federal Reserve Board's Jan. 25 discount rate meeting. "Before the financial crisis, the spread between the primary credit rate and the Committee's target federal funds rate was 100 basis points. Thus, the widening of the spread would be a move toward normalization of the spread, consistent with other steps being taken by the Federal Reserve to normalize its lending programs as financial conditions improve."
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