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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

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4573.

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Date of creation: Dec 1993
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Publication status: published as The Federal Reserve Bank of St. Louis Review, Vol. 76, no. 3 (May/June 1994), pp. 31-55.
Handle: RePEc:nbr:nberwo:4573

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  1. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, American Economic Association, vol. 81(3), pages 497-513, June.
  2. Charles W. Calomiris & Gary Gorton, . "The Origins of Banking Panics: Models, Facts, and Bank Regulation," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 11-90, Wharton School Rodney L. White Center for Financial Research.
  3. Calomiris, Charles W. & Schweikart, Larry, 1991. "The Panic of 1857: Origins, Transmission, and Containment," The Journal of Economic History, Cambridge University Press, Cambridge University Press, vol. 51(04), pages 807-834, December.
  4. Edward J. Kane, 1989. "How Incentive-Incompatible Deposit-Insurance Funds Fail," NBER Working Papers 2836, National Bureau of Economic Research, Inc.
  5. Marvin Goodfriend & Robert G. King, 1988. "Financial deregulation, monetary policy, and central banking," Working Paper, Federal Reserve Bank of Richmond 88-01, Federal Reserve Bank of Richmond.
  6. Larry D. Wall & David R. Peterson, 1989. "The effect of Continental Illinois' failure on the financial performance of other banks," Working Paper, Federal Reserve Bank of Atlanta 89-9, Federal Reserve Bank of Atlanta.
  7. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue May, pages 10-30.
  8. repec:ucp:bknber:9780226355887 is not listed on IDEAS
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Cited by:
  1. Evan Gatev & Philip Strahan, 2008. "Liquidity Risk and Syndicate Structure," NBER Working Papers 13802, National Bureau of Economic Research, Inc.
  2. Michele Fratianni, 2008. "Financial Crises, Safety Nets and Regulation," Mo.Fi.R. Working Papers, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences 5, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  3. Ricardo J. Caballero & Arvind Krishnamurthy, 2008. "Collective Risk Management in a Flight to Quality Episode," Journal of Finance, American Finance Association, American Finance Association, vol. 63(5), pages 2195-2230, October.
  4. 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.
  5. Charles Calomiris, 2000. "Comment on Bordo and Kroszner," Journal of Financial Services Research, Springer, Springer, vol. 18(2), pages 173-177, December.
  6. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, Elsevier, vol. 104(3), pages 425-451.
  7. Mishkin, Frederic S, 1994. "Preventing Financial Crises: An International Perspective," The Manchester School of Economic & Social Studies, University of Manchester, University of Manchester, vol. 62(0), pages 1-40, Suppl..
  8. Selgin, George & Lastrapes, William D. & White, Lawrence H., 2012. "Has the Fed been a failure?," Journal of Macroeconomics, Elsevier, Elsevier, vol. 34(3), pages 569-596.
  9. Philip Strahan, 2008. "Liquidity Production in 21st Century Banking," NBER Working Papers 13798, National Bureau of Economic Research, Inc.
  10. Gary Gorton & Lixin Huang, 2004. "Liquidity, Efficiency, and Bank Bailouts," American Economic Review, American Economic Association, American Economic Association, vol. 94(3), pages 455-483, June.
  11. Arvind Krishnamurthy, 2009. "Amplification Mechanisms in Liquidity Crises," NBER Working Papers 15040, National Bureau of Economic Research, Inc.
  12. 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.
  13. Christopher J. Neely, 2003. "The Federal Reserve responds to crises: September 11th was not the first," Working Papers, Federal Reserve Bank of St. Louis 2003-034, Federal Reserve Bank of St. Louis.

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