Baum, Christopher, and Meral Karasulu. “Modelling Federal Reserve Discount Policy”. Boston College Working Papers in Economics 335, 1996.
We employ threshold cointegration methodology to model the policy problem solved by the Federal Reserve System in their manipulation of the discount rate under a reserves target operating procedure utilized since October 1979. The infrequent and discrete adjustments that characterize movements in the discount rate instrument vis-a- vis the Federal Funds rate do not lend themselves to a linear cointegration framework. The inherently nonlinear relationship arising from the Fed's self-imposed constraints on discontinuously changing the discount rate is satisfactorily modelled as an instance of threshold cointegration between the discount rate and the Federal Funds rate.