TY  - JOUR
AU  - Taylor,John B.
AU  - Williams,John C.
TI  - A Black Swan in the Money Market
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13943
PY  - 2008
Y2  - April 2008
UR  - http://www.nber.org/papers/w13943
L1  - http://www.nber.org/papers/w13943.pdf
N1  - Author contact info:
John B. Taylor
Herbert Hoover Memorial Building
Stanford University
Stanford, CA 94305-6010
Tel: 650/723-9677
Fax: 650-723-1687
E-Mail: John.Taylor@stanford.edu

John Williams
Federal Reserve Bank of San Francisco
Economic Research Department, MS 1130
101 Market St.
San Francisco, CA 94105
Tel: (415) 974-2240
Fax: (415) 974-2168
E-Mail: john.c.williams@sf.frb.org
AB  - 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.
ER  -