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August/September 1986, 
Vol. 68, No. 7
Posted 1986-08-01

The Discount Rate and Market Interest Rates: Theory and Evidence


Daniel L. Thornton discusses the theoretical links between the Federal Reserve’s discount rate and market interest rates and presents some empirical evidence on the extent of this link. He finds that, both in theory and practice, the direct relationship between the discount rate and money market rates is extremely weak. Consequently, any observed relationship between these rates must be due to an expectations effect or to a change in Federal Reserve behavior. If the latter is correct, however, there should have been a stronger association between the discount rate and money market rates following the Federal Reserve’s change in operating procedure in the fall of 1982. Thornton finds, however, that if anything, this relationship has become weaker.





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