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Reconciling Bagehot and the Fed's Response to September 11
Author(s) -
MARTIN ANTOINE
Publication year - 2009
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2009.00210.x
Subject(s) - market liquidity , monetary economics , lender of last resort , economics , interest rate , open market operation , money supply , contrast (vision) , liquidity trap , monetary policy , statutory liquidity ratio , liquidity crisis , central bank , liquidity premium , artificial intelligence , computer science
Bagehot (1873) states that to prevent bank panics a central bank should provide liquidity at a “very high rate of interest.” In contrast, most of the theoretical literature on liquidity provision suggests that central banks should lend at an interest rate of zero. This is broadly consistent with the Federal Reserve's behavior in the days following September 11, 2001. This paper shows that both policies can be reconciled. With commodity money, as in Bagehot's time, liquidity is scarce and a high price allows banks to self‐select. In contrast, the Fed has a virtually unlimited ability to temporarily expand the money supply so self‐selection is unnecessary.