Bank Bailouts and the Conduct of Monetary Policy

Abstract

In fulfilling its obligations as a lender of last resort, a central bank may encounter conflicts with its responsibility to manage the nation's monetary policy.' Crisis lending through the discount window, particularly to save troubled institutions, is viewed by critics of Federal Reserve policy as inflationary and thus undesirable.2 The implicit assumption here is that the lending is not sterilized by open-market sales, leading to an expansion of bank reserves and monetary aggregates. The recent actions of the Fed to assist troubled financial institutions, while well noted in the financial press, have not been systematically analyzed to determine their overall impact, if any, on monetary policy. Using data for the period from 1973 through 1990, we examine whether the Fed's crisis intervention has been sterilized with defensive open-market operations. A second question which we examine is whether the appropriate policy tool for studies of Federal Reserve behavior is nonborrowed reserves or the sum of nonborrowed reserves and extended credit.3