NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Black Swan in the Money Market

John B. Taylor, John C. Williams

NBER Working Paper No. 13943
Issued in April 2008
NBER Program(s):   AP   EFG   IFM   ME

At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions -- including the introduction of a new term auction facility (TAF) --- to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.

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Document Object Identifier (DOI): 10.3386/w13943

Published:

  • John B. Taylor & John C. Williams, 2009. "A Black Swan in the Money Market," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 58-83, January. citation courtesy of
  • John B. Taylor & John C. Williams, 2009. "A black swan in the money market," Proceedings, Federal Reserve Bank of San Francisco, issue Jan. citation courtesy of

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