A black swan in the money market
At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions--including the introduction of a new term auction facility (TAF)--to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.
|Date of creation:||2008|
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- Cúrdia, Vasco & Woodford, Michael, 2016.
"Credit Frictions and Optimal Monetary Policy,"
Journal of Monetary Economics,
Elsevier, vol. 84(C), pages 30-65.
- Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
- Curdia, Vasco & Woodford, Michael, 2015. "Credit frictions and optimal monetary policy," Working Paper Series 2015-20, Federal Reserve Bank of San Francisco, revised 10 Dec 2015.
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- Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium. Full references (including those not matched with items on IDEAS)
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