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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.

Suggested Citation

  • Daniel L. Thornton, 2009. "The Fed, liquidity, and credit allocation," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 13-22.
  • Handle: RePEc:fip:fedlrv:y:2009:i:jan:p:13-22:n:v.91no.1
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    References listed on IDEAS

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    1. John C. Williams & John B. Taylor, 2009. "A Black Swan in the Money Market," American Economic Journal: Macroeconomics, American Economic Association, pages 58-83.
    2. John B. Taylor & John C. Williams, 2009. "A black swan in the money market," Proceedings, Federal Reserve Bank of San Francisco.
    3. Daniel L. Thornton, 2004. "Testing the expectations hypothesis: some new evidence for Japan," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 21-40.
    4. Anderson, Richard G. & Hoffman, Dennis L. & Rasche, Robert H., 2002. "A vector error-correction forecasting model of the US economy," Journal of Macroeconomics, Elsevier, vol. 24(4), pages 569-598, December.
    5. John B. Taylor & John C. Williams, 2008. "A black swan in the money market," Working Paper Series 2008-04, Federal Reserve Bank of San Francisco.
    6. Christopher J. Neely, 2004. "The Federal Reserve responds to crises: September 11th was not the first," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-42.
    7. John B. Taylor & John C. Williams, 2009. "A black swan in the money market," Proceedings, Federal Reserve Bank of San Francisco.
    8. Thornton, Daniel L., 2001. "The Federal Reserve's operating procedure, nonborrowed reserves, borrowed reserves and the liquidity effect," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1717-1739, September.
    9. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
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    Citations

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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, pages 1-17.
    2. Guidolin, Massimo & Tam, Yu Man, 2013. "A yield spread perspective on the great financial crisis: Break-point test evidence," International Review of Financial Analysis, Elsevier, pages 18-39.
    3. Selgin, George & Lastrapes, William D. & White, Lawrence H., 2012. "Has the Fed been a failure?," Journal of Macroeconomics, Elsevier, pages 569-596.
    4. Eric T. Swanson, 2009. "Risk aversion, the labor margin, and asset pricing in DSGE models," Working Paper Series 2009-26, Federal Reserve Bank of San Francisco.
    5. Massimo Guidolin & Yu Man Tam, 2010. "A yield spread perspective on the great financial crisis: break-point test evidence," Working Papers 2010-026, Federal Reserve Bank of St. Louis.
    6. 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, pages 65-81.
    7. Verbruggen, Sandra & Christiaens, Johan & Reheul, Anne-Mie & Van Caneghem, Tom, 2011. "Audit pricing in a reformed nonprofit market," Working Papers 2011/29, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
    8. Leonardo Gambacorta & Boris Hofmann & Gert Peersman, 2014. "The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross‐Country Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(4), pages 615-642, June.
    9. Roland Beck & Sebastian Weber, 2011. "Should Larger Reserve Holdings Be More Diversified?," International Finance, Wiley Blackwell, pages 415-444.
    10. William T. Gavin, 2009. "More money: understanding recent changes in the monetary base," Review, Federal Reserve Bank of St. Louis, pages 49-60.

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