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Liquidity risk, credit risk, and the Federal Reserve's responses to the crisis

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  • Asani Sarkar

Abstract

In responding to the severity and broad scope of the financial crisis that began in 2007, the Federal Reserve has made aggressive use of both traditional monetary policy instruments and innovative tools in an effort to provide liquidity. In this paper, I examine the Fed's actions in light of the underlying financial amplification mechanisms propagating the crisis--in particular, balance sheet constraints and counterparty credit risk. The empirical evidence supports the Fed's views on the primacy of balance sheet constraints in the earlier stages of the crisis and the increased prominence of counterparty credit risk as the crisis evolved in 2008. I conclude that an understanding of the prevailing risk environment is necessary in order to evaluate when central bank programs are likely to be effective and under what conditions the programs might cease to be necessary.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 389.

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Date of creation: 2009
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Handle: RePEc:fip:fednsr:389

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Keywords: Credit ; Liquidity (Economics) ; Risk ; Federal Reserve Bank of New York ; Bank supervision;

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Cited by:
  1. Beaupain, Renaud & Durré, Alain, 2012. "Nonlinear liquidity adjustments in the euro area overnight money market," Working Paper Series 1500, European Central Bank.
  2. Yang, Hsin-Feng & Liu, Chih-Liang & Chou, Ray Yeutien, 2014. "Interest rate risk propagation: Evidence from the credit crunch," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 242-264.
  3. Fratzscher, Marcel & Lo Duca, Marco & Straub, Roland, 2013. "On the international spillovers of US quantitative easing," Working Paper Series 1557, European Central Bank.
  4. Vasco Curdia & Michael Woodford, . "The Central-Bank Balance Sheet as an Instrument of Monetary Policy," Discussion Papers 0910-19, Columbia University, Department of Economics.
  5. Yi Wang, 2010. "Convertibility Restriction Determination in China's Foreign Exchange Market and its Impact of Forward Pricing," Discussion Papers 09-024, Stanford Institute for Economic Policy Research.
  6. Dalia Hakura & Ralph Chami & Thomas F. Cosimano & Adolfo Barajas, 2010. "U.S. Bank Behavior in the Wake of the 2007-2009 Financial Crisis," IMF Working Papers 10/131, International Monetary Fund.
  7. Clara Lia Machado & Carlos León & Miguel Sarmiento & Orlando Chipatecua, 2010. "Riesgo Sistémico y Estabilidad del Sistema de Pagos de Alto Valor en Colombia: Análisis bajo Topología de Redes y Simulación de Pagos," BORRADORES DE ECONOMIA 007669, BANCO DE LA REPÚBLICA.
  8. Andre Guettler & Ulrich Hommel & Julia Reichert, 2011. "The influence of sponsor, servicer, and underwriter characteristics on RMBS performance," Financial Markets and Portfolio Management, Springer, vol. 25(3), pages 281-311, September.
  9. James Felkerson, 2012. "Fiddling in Euroland as the Global Meltdown Nears," Economics Public Policy Brief Archive ppb_123, Levy Economics Institute.
  10. James Felkerson, 2011. "$29,000,000,000,000: A Detailed Look at the Fed's Bailout by Funding Facility and Recipient," Economics Working Paper Archive wp_698, Levy Economics Institute.
  11. Beaupain, Renaud & Durré, Alain, 2013. "Central bank reserves and interbank market liquidity in the euro area," Journal of Financial Intermediation, Elsevier, vol. 22(2), pages 259-284.
  12. Fratzscher, Marcel & Lo Duca, Marco & Straub, Roland, 2012. "A global monetary tsunami? On the spillovers of US Quantitative Easing," CEPR Discussion Papers 9195, C.E.P.R. Discussion Papers.

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