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

  • Antoine Martin

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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  1. 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.
  2. Jean-Charles Rochet & Xavier Vives, 2004. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1116-1147, December.
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  6. Thomas M. Humphrey & Robert E. Keleher, 1984. "The lender of last resort : a historical perspective," Working Paper 84-03, Federal Reserve Bank of Richmond.
  7. Hirsch, Fred, 1977. "The Bagehot Problem," The Manchester School of Economic & Social Studies, University of Manchester, vol. 45(3), pages 241-57, September.
  8. Repullo, Rafael, 2000. "Who Should Act as Lender of Last Resort? An Incomplete Contracts Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 580-605, August.
  9. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  10. 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.
  11. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  12. Christopher Sleet & Bruce D. Smith, 2000. "Deposit insurance and lender-of-last-resort functions," Proceedings, Federal Reserve Bank of Cleveland, pages 518-579.
  13. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group.
  14. François R. Velde & Warren E. Weber, 1998. "A model of bimetallism," Working Papers 588, Federal Reserve Bank of Minneapolis.
  15. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  16. 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.
  17. Luisa Lambertini, 2001. "Volatility and Sovereign Default," Boston College Working Papers in Economics 577, Boston College Department of Economics.
  18. 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.
  19. Cooper, Russell & Corbae, Dean, 2002. "Financial Collapse: A Lesson from the Great Depression," Journal of Economic Theory, Elsevier, vol. 107(2), pages 159-190, December.
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