What did Fed do after the breakdown of credit markets?
The European Central Bank (ECB) injected funds on August 9 as liquidity and credit problems loomed large. Signs of illiquid markets also became visible in various money markets and credit markets in the US. For example, three-month Eurodollar loans carried an interest tag of about 247 basis points more than the yield on 3-month Treasury bills in recent days. The spread between these two short-term securities reflects the risk in lending to banks, which in months before August had averaged at about 50 basis points. The Fed considered the old policy prescription suggested first by Walter Bagehot, a nineteenth century economist and journalist. In his opinion, central banks should lend to solvent banks in large quantities but with a penalty in times of financial market turbulence. The Fed lowered the discount rate and was standing by to lend in abundant quantities. Typically, the Fed uses the federal funds rate or the policy rate to signal changes in monetary policy in order to maintain pr
