The Fed’s control over money markets has always been tenuous, a myth more than anything, it just wasn’t so obvious at one time. That observation extends to its grasp of even basic operations, a spectacular fail revealed by its 2000’s treatment of the Discount Window. On January 9, 2003, the FOMC altered decades of monetary history by switching the Discount Rate. In reality, it didn’t so much shift the rate as redefine the program in yet more belated recognition that banking had drastically evolved.

The Discount Window had in the Fed’s early years been the primary monetary tool, as banks would borrow reserves directly from the one of the Federal Reserve branches. And even the 12 Fed banks would set their own Discount Rates, such was the regionally fragmented structure of national liquidity. The rise of federal funds around 1925 altered the behavior (owing in part to the Fed stumbling upon open market operations by complete accident), reducing the importance of the Discount Window in regular monetary operations. It wasn’t long before the Fed itself actively discouraged direct and chronic borrowing so that federal funds by the 1960’s was the entirety of reserve management.

That left the Discount rate as what most people think of it, the Fed as lender of last resort. The rate was traditionally set below the federal funds rate as an accommodation to those kinds of circumstances – restriction in use of the Window’s facilities was accomplished by administration rather than cost. Starting January 2003, the Fed actually replaced the Discount Window with a tiered structure called Primary and Secondary credit; the Primary rate to be set 100 bps above the federal funds target.

The idea was to create a monetary corridor for money market rates. The Primary Credit rate at a premium would act as a ceiling in several respects. First, the shift to something other than the Discount Window was intended to end the stigma associated with it that had been developed during the period where it was highly discouraged in favor of federal funds. The rule change to primary credit (why it is called primary credit) removed the restriction against relending any federal funds borrowed there. Prior, any bank borrowing at the traditional Discount Window was prohibited from further distributing those funds; again, last resort.