Discussion Paper

The Fed Funds Market during the 2007-09 Financial Crisis

Abstract: The U.S. federal funds market played a central role in the financial system during the 2007-09 crisis, because it was the market which provided banks with immediate liquidity, even late in the day. Interpreting changes in fed funds rates is notoriously difficult, however, as many of the economic drivers behind the rates are simultaneously changing. In this post, I highlight results from a working paper which untangles the impact of these economic drivers and measures their respective effects on the marketplace using data over a sample period leading up to and during the financial crisis. The analysis shows that the spread between fed funds sold and bought widened because of increases in counterparty risk. Further, there was a large increase in the supply of cash into this market, suggesting that banks viewed fed funds as a relatively safe place to invest cash in a crisis environment.

Keywords: asymmetric information; fed funds; financial crisis; intermediation;

JEL Classification: E5; G21; G01;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2020-11-10

Number: 20201110