Reconciling Bagehot with the Fed's response to Sept. 11

Antoine Martin

No RWP 02-10, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: Bagehot (1873) states that in order to prevent bank panics a central bank should provide liquidity to the market at a \"very high rate of interest\". This seems to be in sharp contrast with the policy adopted by the Federal Reserve after September 11 when, for a few days, the Federal Funds Rate was very close to zero. This paper shows that Bagehot's recommendation can be reconciled with the Fed's policy if one recognizes that Bagehot has in mind a commodity money regime so that the amount of reserves available is limited. A high price for this liquidity allows banks that need it most to self-select. In contrast, the Fed has a virtually unlimited ability to temporarily expand the money supply.

Keywords: Liquidity (Economics); lenders of last resort (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-mac
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