What to Make of the Discount Rate Increase?

Markets were surprised by the Fed's increase of the discount rate yesterday. They are debating to what extent this means the Fed will raise rates sooner rather than later. My view: this is liquidity policy, not monetary policy.

Together with raising the discount rate, the Fed also raised the minimum bid rate on the TAF. In other words, the Fed is making it more painful for banks to rely on the authorities for lending instead of going to the market. This is likely to be especially difficult for less healthy banks, as it should be.

In short, monetary policy is about managing demand in the economy. Liquidity policy is about ensuring the stability of the financial sector. The Fed's discount window is about ensuring stability for banks, and raising this rate is about pushing the banking sector off of public support, rather than managing the economy.