Discussion — Lectures 11 & 12

This session covers Lecture 11: Banks and the Market for Liquidity and Lecture 12: Lender/Dealer of Last Resort.

• Lecture 11 Notes
• Lecture 12 Notes

Lecture 11 generalizes the Treynor model from security dealers to the term funding market and the overnight money market. It also examines the puzzle of why it's profitable for banks to run the payment system at par, a price that can't move, and that has no bid/ask spread. We discuss how the Fed manages interest rates (floor vs. corridor system) and the evolution of market-based finance—i.e. shadow banking.

Lecture 12 uses our triple Treynor diagram from Lecture 11 describe how monetary policy transmits from overnight rates to asset prices. In 2008, a breakdown of this transmission mechanism forced the Fed to transition from a mere lender of last resort in the money market (funding liquidity) to a full-blown dealer of last resort in the capital market (market liquidity).

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