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Reconciling Bagehot and the Fed's Response to September 11

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  • ANTOINE MARTIN

Abstract

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. Copyright (c) 2009 Federal Reserve Bank of New York with Exclusive License to Print by The Ohio State University.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 41 (2009)
Issue (Month): 2-3 (03)
Pages: 397-415

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Handle: RePEc:mcb:jmoncb:v:41:y:2009:i:2-3:p:397-415

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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Cited by:
  1. Hiroshi Fujiki, 2010. "Policy Measures to Alleviate Foreign Currency Liquidity Shortages under Aggregate Risk with Moral Hazard," IMES Discussion Paper Series 10-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Xavier Freixas & Antoine Martin & David Skeie, 2009. "Bank liquidity, interbank markets, and monetary policy," Staff Reports 371, Federal Reserve Bank of New York.

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