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Reconciling Bagehot with the Fed's response to September 11

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  • Antoine Martin

Abstract

The nineteenth-century economist Walter Bagehot maintained that in order to prevent bank panics, a central bank should provide liquidity at a very high rate of interest. However, most of the theoretical literature on liquidity provision suggests that central banks should lend at an interest rate of zero. This latter recommendation is broadly consistent with the Federal Reserve’s behavior in the days following September 11, 2001. This paper shows that Bagehot’s recommendation can be reconciled with the Fed’s policy if one recognizes that Bagehot had in mind a commodity money regime in which the amount of reserves available is limited. A high price for this liquidity allows banks that need it most to self-select. To the contrary, the Fed has a virtually unlimited ability to temporarily expand the money supply so that self-selection is unnecessary.

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  • Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:217
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    References listed on IDEAS

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    Cited by:

    1. Gu, Chao & Guzman, Mark & Haslag, Joseph, 2011. "Production, hidden action, and the payment system," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 172-182, March.
    2. Calomiris, Charles W. & Flandreau, Marc & Laeven, Luc, 2016. "Political foundations of the lender of last resort: A global historical narrative," Journal of Financial Intermediation, Elsevier, vol. 28(C), pages 48-65.
    3. 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.
    4. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.

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    Keywords

    Money supply ; Monetary policy ; Liquidity (Economics) ; Federal funds rate ; War - Economic aspects;

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