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The responses of the prime rate to change in policies of the Federal Reserve

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  • Friedman, Joseph
  • Shachmurove, Yochanan

Abstract

This paper examines how commercial banks reacted to the changes in monetary tools in mid-1994, when The Federal Reserve Bank altered its policy by implicitly targeting the Federal Funds Rate (FFR). Prior to 1994, the FFR had a lagged effect on the prime rate that charged commercial banks their best customers. However, after the move by the FED in 1994, commercial banks responded immediately by changing their prime lending rate to the Federal Funds Rate plus a three-percent spread. The result is important because it demonstrates how a more transparent monetary policy targeting can have, in fact, the desired effect.

Suggested Citation

  • Friedman, Joseph & Shachmurove, Yochanan, 2015. "The responses of the prime rate to change in policies of the Federal Reserve," Economic Modelling, Elsevier, vol. 46(C), pages 407-411.
    • Handle: RePEc:eee:ecmode:v:46:y:2015:i:c:p:407-411
    DOI: 10.1016/j.econmod.2014.12.042
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    References listed on IDEAS

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    1. Forbes, Shawn M. & Mayne, Lucille S., 1989. "A friction model of the prime," Journal of Banking & Finance, Elsevier, vol. 13(1), pages 127-135, March.
    2. MacKinnon, James G, 1996. "Numerical Distribution Functions for Unit Root and Cointegration Tests," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 601-618, Nov.-Dec..
    3. Jianzhou Zhu & Manfen Chen & Wanli Li, 2009. "Recent changes in the prime rate behavior," Review of Quantitative Finance and Accounting, Springer, vol. 33(2), pages 177-192, August.
    4. Rik Hafer, 1983. "The prime rate and the cost of funds: is the prime too high?," Review, Federal Reserve Bank of St. Louis, vol. 65(May), pages 17-21.
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    Cited by:

    1. Heung Soon Jung & Dong Jin Lee & Tae Hyo Gwon & Se Jin Yun, 2015. "Reference Rates and Monetary Policy Effectiveness in Korea," Working Papers 2015-27, Economic Research Institute, Bank of Korea.

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    More about this item

    Keywords

    Federal Funds Rate; Prime rate; Federal Reserve Bank; Monetary policy; Commercial banks; Vector Auto Regression (VAR); Vector Error Correction (VEC); Interest rate targeting; Unit root tests; Granger causality; Variance decomposition;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G00 - Financial Economics - - General - - - General
    • G2 - Financial Economics - - Financial Institutions and Services
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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