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Reconciling Bagehot with the Fed's response to Sept. 11

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Author Info
Antoine Martin

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Abstract

Bagehot (1873) states that in order to prevent bank panics a central bank should provide liquidity to the market at a "very high rate of interest". This seems to be in sharp contrast with the policy adopted by the Federal Reserve after September 11 when, for a few days, the Federal Funds Rate was very close to zero. This paper shows that Bagehot's recommendation can be reconciled with the Fed's policy if one recognizes that Bagehot has in mind a commodity money regime so that the amount of reserves available is limited. A high price for this liquidity allows banks that need it most to self-select. In contrast, the Fed has a virtually unlimited ability to temporarily expand the money supply.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 02-10.

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Date of creation: 2002
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Handle: RePEc:fip:fedkrw:rwp02-10

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Keywords: Liquidity (Economics) ; Lenders of last resort;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group. [Downloadable!] (restricted)
  5. Antoine Martin, 2001. "Liquidity provision vs. deposit insurance : preventing bank panics without moral hazard?," Research Working Paper RWP 01-05, Federal Reserve Bank of Kansas City. [Downloadable!]
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  6. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February. [Downloadable!] (restricted)
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  9. Antinolfi, Gaetano & Huybens, Elisabeth & Keister, Todd, 2001. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 187-219, July. [Downloadable!] (restricted)
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  10. Bryant, John & Wallace, Neil, 1980. "Open-Market Operations in a Model of Regulated, Insured Intermediaries," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 146-73, February. [Downloadable!] (restricted)
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  12. Repullo, R., 1999. "Who Should Act as Lender of Last Resort? An Incomplete Contracts Model," Papers 9913, Centro de Estudios Monetarios Y Financieros-.
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  13. Stephen D. Williamson, 1998. "Discount Window Lending and Deposit Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 246-275, January. [Downloadable!] (restricted)
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  14. David Laidler, 2002. "Two Views of the Lender of Last Resort: Thornton and Bagehot," UWO Department of Economics Working Papers 20029, University of Western Ontario, Department of Economics. [Downloadable!]
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  15. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  16. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall. [Downloadable!] (restricted)
  17. Hirsch, Fred, 1977. "The Bagehot Problem," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 45(3), pages 241-57, September.
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  1. ROCHET, Jean-Charles & VIVES, Xavier, 2004. "Coordination Failures and the Lender of Last Resort : Was Bagehot Right After All?," IDEI Working Papers 294, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
    Other versions:
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