Liquidity risk, credit risk, and the Federal Reserve's responses to the crisis

Asani Sarkar

No 389, Staff Reports from Federal Reserve Bank of New York

Abstract: In responding to the severity and broad scope of the financial crisis that began in 2007, the Federal Reserve has made aggressive use of both traditional monetary policy instruments and innovative tools in an effort to provide liquidity. In this paper, I examine the Fed's actions in light of the underlying financial amplification mechanisms propagating the crisis--in particular, balance sheet constraints and counterparty credit risk. The empirical evidence supports the Fed's views on the primacy of balance sheet constraints in the earlier stages of the crisis and the increased prominence of counterparty credit risk as the crisis evolved in 2008. I conclude that an understanding of the prevailing risk environment is necessary in order to evaluate when central bank programs are likely to be effective and under what conditions the programs might cease to be necessary.

Keywords: Credit; Liquidity (Economics); Risk; Federal Reserve Bank of New York; Bank supervision (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-mac, nep-mon and nep-rmg
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Journal Article: Liquidity risk, credit risk, and the federal reserve’s responses to the crisis (2009)
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