Market and Public Liquidity

As the record of Federal Reserve interventions over the past year, from December 2007 to December 2008, makes abundantly clear, a foremost concern of monetary authorities in responding to the financial crisis has been to avoid a repeat of the Great Depression, and especially a repeat of the monetary contraction that Milton Friedman and Anna Schwartz (1963) have claimed as the major cause of the 1930s Depression. The Fed has shown tremendous resourcefulness and inventiveness in its liquidity injections, considerably widening the collateral eligible under the discount window and the term auction facility, and setting up new programs targeted at primary dealers, the commercial paper market, and money market funds. At the same time it has stepped in to offer guarantees on assets held by some financial institutions (e.g., Citigroup) to avoid their bankruptcy (see David Enrich et al. 2008). This unprecedented intervention has had the intended effect of averting a major systemic financial meltdown and it has kept some critical financial institutions afloat. Yet, until now, banks have mostly responded by cutting new lending and hoarding liquidity, so that the ultimate goal of forestalling a credit crunch has not been achieved. For the most part, banks also are still holding most of the toxic assets that Monetary Policy, liquidity, and Financial crises †