Discount window borrowing, monetary policy, and the post-October 6, 1979 federal reserve operating procedure

Abstract

A demand schedule for discount window borrowing based on profit-maximizing bank behavior is derived. A feature of non-price rationing at the discount window making longer duration borrowing more costly is shown to make lagged borrowing and expected future spreads between the Federal funds rate and the discount rate relevant to the current borrowing decision. Consequently, both the size of the coefficients in the borrowing functions as well as the form of the function itself depend on expected Fed policy toward the spread. The demand function for discount window borrowing provides the critical link by which non-borrowed reserve control affects short-term interest rates and ultimately the money supply under post-October 6, 1979 reserve targeting. The analysis suggests some reasons why the Fed has experienced difficulty in specifying, estimating, and utilizing a discount window borrowing function in the non-borrowed reserve operating procedure.