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Reconciling Bagehot with the Fed's response to September 11
The nineteenth-century economist Walter Bagehot maintained that in order to prevent bank panics, a central bank should provide liquidity at a very high rate of interest. However, most of the theoretical literature on liquidity provision suggests that central banks should lend at an interest rate of zero. This latter recommendation is broadly consistent with the Federal Reserve?s behavior in the days following September 11, 2001. This paper shows that Bagehot?s recommendation can be reconciled with the Fed?s policy if one recognizes that Bagehot had in mind a commodity money regime in which ...