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

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.