The Federal Reserve Board dropped its discount rate by 1 percentage point yesterday to 10 percent. The move was widely expected after two major banks cut their prime rate to 10 3/4 percent on Thursday.
At the same time, money supply figures released by the Fed yesterday showed that both of the narrow measures of money supply increased slightly in the week ended July 16 (table on Page G4). That came after a drop in the two preceding weeks. The measures are M1-A (cash and demand deposits) and M1-B (M1-A plus all checking accounts with thrift institutions).
Yesterday's figures showed that M1-A rose to a seasonally adjusted average of $374.8 billion in the week ended July 16 from $372.3 billion in the previous week. M1-B's increase was to a seasonally adjusted average of $395.7 billion from $393 billion.
The Fed said yesterday's reduction "is a purely technical adjustment to bring the discount rate into alignment with the level of short-term market interest rates and bank lending rates."
The discount rate is the interest charged for borrowings from the district Federal Reserve banks. It is not very important as a guide to the cost of money to banks because the Fed frowns on frequent borrowings from the discount window.
Since the switch of emphasis in the Fed's money policy towards using bank reserve growth rather than interest rates to control the growth in the money supply, changes in the discount rate have had little significance as an indicator of the Fed's basic money stance.
However, they can influence the dollar on the foreign exchange markets because foreigners still use the discount rate to some extent as an indicator of Fed policy.
Some bankers have suggested that this is why the Fed did not lower the discount rate until after Chase Manhattan and Chemical banks had dropped their prime lending rates below it. Thus the Fed clearly was following the market rather than leadingit.
The Fed acted yesterday in response to requests from the directors of Federal Reserve banks in New York, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco.
The Fed Board of Governors approved the reduction in a 5-to-0 vote. Frederick Schultz and Charles Partee were not present.
Fed Chairman Paul Volcker said in testimony to Congress earlier this week that the Fed was prepared to see money growth below the midpoint of its target ranges this year. Although the money supply now is showing signs of growth, there were sharp falls earlier this year.