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The Fed, liquidity, and credit allocation

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  • Daniel L. Thornton

Abstract

The current financial turmoil has generated considerable discussion of liquidity. Moreover, it has been widely reported that the Federal Reserve played a major role in supplying liquidity to financial markets during this distressed time. This article describes two ways in which the Fed has supplied liquidity since late 2007. The first is traditional: The Fed supplies liquidity by providing credit through open market operations and by lending to depository institutions at the so-called discount window. The second is by enhancing the liquidity of portfolios of some institutions by replacing their less-liquid assets with more-liquid assets. The Fed has used the second approach since late 2007. Unlike several previous occasions, however, it began supplying liquidity in the first, more traditional way only recently-in September 2008. This article notes that the Fed departed from its long-standing tradition of minimizing its effect on the allocation of credit by supplying liquidity to institutions that it believed to be most in need; at the same time, it neutralized the effects of these actions on the total supply of liquidity in the financial market. The article also discusses the Fed's reasons for reallocating credit this time rather than simply increasing the total supply of financial market liquidity.

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Bibliographic Info

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

Volume (Year): (2009)
Issue (Month): Jan ()
Pages: 13-22

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Handle: RePEc:fip:fedlrv:y:2009:i:jan:p:13-22:n:v.91no.1

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Related research

Keywords: Liquidity (Economics) ; Financial crises ; Credit - United States;

References

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  1. Daniel L. Thornton, 1998. "The Federal Reserve's operating procedure, nonborrowed reserves, borrowed reserves and the liquidity effect," Working Papers 1998-009, Federal Reserve Bank of St. Louis.
  2. John B. Taylor & John C. Williams, 2008. "A Black Swan in the Money Market," NBER Working Papers 13943, National Bureau of Economic Research, Inc.
  3. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
  4. Christopher J. Neely, 2003. "The Federal Reserve responds to crises: September 11th was not the first," Working Papers 2003-034, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Phillip Anthony O’Hara, 2011. "International Subprime Crisis and Recession: Emerging Macroprudential, Monetary, Fiscal and Global Governance," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(1), pages 1-17, March.
  2. Daniel L. Thornton, 2012. "How did we get to inflation targeting and where do we need to go to now? a perspective from the U.S. experience," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 65-81.
  3. William T. Gavin, 2009. "More money: understanding recent changes in the monetary base," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 49-60.
  4. L. Gambacorta & B. Hofmann & G. Peersman, 2011. "The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross-Country Analysis," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 11/765, Ghent University, Faculty of Economics and Business Administration.
  5. 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.
  6. Christiano, Lawrence & Rostagno, Massimo & Motto, Roberto, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.

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