Olivier Armantier, Helene Lee, and Asani Sarkar — History of Discount Window Stigma

The Fed stands ready with overdrafts as the lender of last resort, but there is a greater price to pay than the penalty rate — loss of institutional credibility and reputation due to either sub-standard ALM practice or financial weakness.  The Fed attempted to change that in 2003, and even tried to reverse the perception at the time of the financial crisis as part of its gargantuan effort to stabilize the system.

The post-reform DW is more consistent with Walter Bagehot’s classical principles that central banks should lend freely to illiquid but solvent institutions against good collateral but at a penalty over the “normal” market rate. By lending freely, central banks create an expectation that they will be available to provide as much liquidity as is needed during a crisis and alleviate the high demand for liquidity that triggers most crises. By charging a penalty rate, they ensure that banks borrow as a last resort.

The 2003 reforms, however, do not appear to have removed the perception of DW stigma, as shown in “Discount Window Stigma during the 2007-2008 Financial Crisis,” and DW borrowing generally remained sparse (see the second chart, above). A plausible explanation for the persistence of DW stigma is that the old policies left lasting perceptions of the DW, which, among other factors, may have dissuaded banks from readily using it to this day.

FRBNY— Liberty Street Economics
History of Discount Window Stigma
Olivier Armantier, Helene Lee, and Asani Sarkar

Brad DeLong on Economics in Crisis

The most interesting moment at a recent conference held in Bretton Woods, New Hampshire – site of the 1945 conference that created today’s global economic architecture – came when Financial Times columnist Martin Wolf quizzed former United States Treasury Secretary Larry Summers, President Barack Obama’s ex-assistant for economic policy. '[Doesn’t] what has happened in the past few years,” Wolf asked, “simply suggest that [academic] economists did not understand what was going on?'

"Here is the most interesting part of Summers’ long answer: 'There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger.' That may sound obscure to a non-economist, but it was a devastating indictment....

"...He talked about 'the revolution in finance as it was realized that asset prices show large volatility that does not reflect anything about fundamentals,' but added that 'macroeconomics [did not] keep up with [this] revolution.' As a result, 'to the great detriment of contemporary macroeconomics,' his fellow economists did not understand asset prices, manias, panics, and liquidity...."

Read the rest: Economics in Crisis

Maybe Prof. DeLong will wake up to MMT and learn that some "heterodox economists" have been working in this field for decades.