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Title:Reconciling Bagehot with the Fed's response to September 11 PDF Logo
Authors:Martin, Antoine
Issue Date:2005
Series/Report no.:Staff Report, Federal Reserve Bank of New York 217
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.
Subjects:liquidity provision
lender of last resort
Bagehot
commodity money
JEL:E4
E5
G2
Document Type:Working Paper
Appears in Collections:Staff Reports, Federal Reserve Bank of New York

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