A Black Swan in the Money Market

John Taylor and John Williams

No 13943, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions -- including the introduction of a new term auction facility (TAF) --- to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.

JEL-codes: E43 E44 E52 (search for similar items in EconPapers)
Date: 2008-04
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-ure
Note: AP EFG IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (109)

Published as John B. Taylor & John C. Williams, 2009. "A Black Swan in the Money Market," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 58-83, January.
Published as John B. Taylor & John C. Williams, 2009. "A black swan in the money market," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.

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Journal Article: A Black Swan in the Money Market (2009)
Journal Article: A black swan in the money market (2009)
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