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Is the discount window necessary? a Penn Central perspective

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  • Charles W. Calomiris

Abstract

The discount window has been under attack recently as a costly and unnecessary tool of policy. This paper argues that the primary role of the discount window should be to provide occasional, temporary support to particular financial markets during localized financial crises. The benefits of the discount window revolve around information externalities across firms resulting from confusion over the incidence of bad news, or reductions in the net worth of market intermediaries. The history of the Penn Central commercial paper crisis of 1970, and the Fed's use of the discount window to combat that crisis, are reviewed. The crisis is visible in a pronounced decline in outstanding commercial paper, an increase in the interest rate spreads for commercial paper and for long-term debt, and declines in stock prices. Cross-sectional variation in abnormal stock returns indicates that, controlling for other factors, firms that were likely to have had outstanding debt in the form of commercial paper suffered larger negative returns during the onset of the crisis, and larger positive returns after the Fed intervened to lower the cost of commercial paper rollover. Implications of the 1970 crisis for current financial markets, and for discount window policy, are considered in light of this evidence.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (1994)
Issue (Month): May ()
Pages: 31-55

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Handle: RePEc:fip:fedlrv:y:1994:i:may:p:31-55

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Keywords: Discount window;

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References

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  1. Charles W. Calomiris & Gary Gorton, 1991. "The Origins of Banking Panics: Models, Facts, and Bank Regulation," NBER Chapters, in: Financial Markets and Financial Crises, pages 109-174 National Bureau of Economic Research, Inc.
  2. Calomiris, Charles W. & Schweikart, Larry, 1991. "The Panic of 1857: Origins, Transmission, and Containment," The Journal of Economic History, Cambridge University Press, vol. 51(04), pages 807-834, December.
  3. Larry D. Wall & David R. Peterson, 1989. "The effect of Continental Illinois' failure on the financial performance of other banks," Working Paper 89-9, Federal Reserve Bank of Atlanta.
  4. Edward J. Kane, 1989. "How Incentive-Incompatible Deposit-Insurance Funds Fail," NBER Working Papers 2836, National Bureau of Economic Research, Inc.
  5. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, issue May, pages 10-30.
  6. Goodfriend, M. & King, R.G., 1988. "Financial Deregulation, Monetary Policy, And Central Banking," RCER Working Papers 121, University of Rochester - Center for Economic Research (RCER).
  7. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
  8. repec:ucp:bknber:9780226355887 is not listed on IDEAS
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Citations

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Cited by:
  1. Gary Gorton & Lixin Huang, 2004. "Liquidity, Efficiency, and Bank Bailouts," American Economic Review, American Economic Association, vol. 94(3), pages 455-483, June.
  2. Fratianni Michele, 2008. "Financial Crises, Safety Nets and Regulation," Rivista italiana degli economisti, Società editrice il Mulino, issue 2, pages 169-208.
  3. Mishkin, Frederic S, 1994. "Preventing Financial Crises: An International Perspective," The Manchester School of Economic & Social Studies, University of Manchester, vol. 62(0), pages 1-40, Suppl..
  4. Arvind Krishnamurthy, 2009. "Amplification Mechanisms in Liquidity Crises," NBER Working Papers 15040, National Bureau of Economic Research, Inc.
  5. Charles Calomiris, 2000. "Comment on Bordo and Kroszner," Journal of Financial Services Research, Springer, vol. 18(2), pages 173-177, December.
  6. Selgin, George & Lastrapes, William D. & White, Lawrence H., 2012. "Has the Fed been a failure?," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 569-596.
  7. Charles W. Calomiris & Athanasios Orphanides & Steven A. Sharpe, 1994. "Leverage as a State Variable for Employment, Inventory Accumulation, andFixed Investment," NBER Working Papers 4800, National Bureau of Economic Research, Inc.
  8. Gary Gorton & Andrew Metrick, 2010. "Securitized Banking and the Run on Repo," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  9. Philip Strahan, 2008. "Liquidity Production in 21st Century Banking," NBER Working Papers 13798, National Bureau of Economic Research, Inc.
  10. Evan Gatev & Philip Strahan, 2008. "Liquidity Risk and Syndicate Structure," NBER Working Papers 13802, National Bureau of Economic Research, Inc.
  11. Christopher J. Neely, 2004. "The Federal Reserve responds to crises: September 11th was not the first," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-42.
  12. Ricardo J. Caballero & Arvind Krishnamurthy, 2008. "Collective Risk Management in a Flight to Quality Episode," Journal of Finance, American Finance Association, vol. 63(5), pages 2195-2230, October.
  13. Pu Shen, 2003. "Why has the nonfinancial commercial paper market shrunk recently?," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 55-76.

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