The Responses of the Prime Rate to a Change in Policies of the Federal Reserve

This paper studies the reactions of commercial banks to the changes in monetary policy tools in mid-1994, when the Federal Reserve Bank altered its policy implicitly targeting the Federal Funds Rate (FFR). Prior to 1994, the FFR had affected, with a considerable lag, the Prime Rate. 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. Based on the response of commercial banks, it is evident that a more transparent monetary policy can, in fact, more effectively achieve its underlying objectives.