Question

Analyze the Fed’s reaction to the Sept. 11 terrorist attacks.

Answer 1

The terrorist attacks on the World Trade Center and the Pentagon were not just a human tragedy but had potentially serious economic ramifications. The Attacks ' most immediate economic impact was a temporary failure to clear checks, triggered by flight suspension. The New York Stock Exchange and other financial markets were closed for the remainder of the week. Many individuals withdrew money from the bank, perhaps afraid of further attacks. Similarly, companies moved money from illiquid assets, such as stocks and bonds, to liquid assets, such as account checks.

The response of the Federal Reserve to the immediate effects of the attacks was to provide liquidity-the ability to make payments-to companies and individuals. Particularly important was the provision of liquidity to financial firms, which are continuously buying and selling assets, as they have to make payments with either funds from recently sold assets or money borrowed from banks. Nonetheless, banks avoid making these loans during times of crisis, because declining asset prices threaten the value of the collateral. An interruption of bank loans to financial firms could potentially trigger a domino chain of bankruptcies that would halt the financial system.

New York Trading Desk of the Fed has bought a very large amount of U.S. Treasury securities, either directly or through repurchase agreements.These deals offered market liquidity by transfering capital (a liquid asset) to the public in return for Treasury securities (a less liquid asset). On Sept. 12, the Fed kept $61 billion in securities purchased under repurchase agreements, vs. an average of $27 billion on the previous 10 Wednesdays and about $12 billion a year ago.

The Fed has taken steps to raise liquidity for foreign banks with US offices or subsidiaries. In order to enable foreign central banks to provide these services in U.S. dollars, the Federal Reserve quickly established "swap lines" with the Bank of England and the European Central Bank, and increased the swap line with the Bank of Canada. The swap lines are similar to credit lines; they allow central banks to exchange currencies temporarily.