Bagehot’s Lessons for the Fed

Apropos to our earlier criticism of the US Central Bank is this piece by Stanford prof Ronald McKinnon, titled Bagehot’s Lessons for the Fed.

In today’s WSJ, McKinnon writes:

"By slashing interest rates too much in 2007-2008, the
Fed has accentuated the foreign drain and thus made the alleviation of
the domestic drain more difficult. Yet, despite this mistake, Bagehot
would approve of other actions the Fed has taken to deal with the
domestic drain by unblocking specific impacted domestic markets. These
include (1) swapping Treasury bonds for less safe private bonds, (2)
opening its discount window to shaky borrowers, and (3) maybe even
rescuing Bear Sterns. He would also approve of the relaxation of
capital constraints on Fannie Mae, Freddy Mac and so on, for mortgage
lending. Yet these measures will be insufficient if the foreign drain

To repeat Bagehot’s Rule: "very large (domestic) loans
at very high rates are the best remedy for the worst malady of the
money market when a foreign drain is added to a domestic drain." The
Fed, and the U.S. government more generally, have so far got it only
half right."

The entire piece is worth a read . . .


Bagehot’s Lessons for the Fed
WSJ, April 25, 2008

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