William C Dudley: The Federal Reserve's liquidity facilities Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Vanderbilt University Conference on Financial Markets and Financial Policy Honoring Dewey Daane, Nashville, Tennessee, 18 April 2009. *  *  *  Thank you for having me here today. It is a great honor to be on a panel with Peter Fisher and Bill Poole. I am the neophyte here in terms of central banking experience! Before I begin, let me emphasize that my comments represent my own views and opinions and do not necessarily reflect the views of the Federal Open Market Committee or of the Federal Reserve System. I am going to talk today about the Fed’s provision of liquidity to banks and dealers and to market participants more generally. I would break down our actions into three broad classes. First, we addressed the acute seizing up of inter-bank financing markets. For banks, we introduced the Term Auction Facility in December 2007 and for the primary dealers, the Term Securities Lending Facility and Primary Dealer Credit Facility in March 2008. In addition, the Federal Reserve entered into FX swap agreements with major global central banks in order to channel dollar liquidity to banks overseas. Second, we expanded our provision of short term financing beyond banks and dealers in order to alleviate constraints on highly rated corporate borrowers.
Since then, especially during the nineties, economists documented several puzzles in the behavior of households' consumption. For example, the results by Deaton and Carroll show that the ability of households to smooth consumption was imperfect and heterogeneous. This evidence challenged the predictions of models with complete markets and a representative agent. One of the main milestones in this literature in the early nineties was the development of economic models with uninsurable income risk and credit constraints that displayed rich cross-sectional heterogeneity in income and wealth, the so-called heterogeneous agent models, or Bewley-Huggett economies. The main takeaway from these earlier models is that one could rationalize the low observed real interest rate, inconsistent with representative agent models with complete markets, in a model in which households have precautionary savings motives to insure against income shocks. In this framework, the degree of income uncertainty and credit constraints shape wealth inequality and imply a real interest rate in equilibrium that better resembles that in the data. Another key development was the widespread increase in access to large-scale microdata, which helped the profession to evaluate existing economic theories and build better economic models. Microdata has been a cornerstone to the inclusion of heterogeneity into macroeconomic models, as it allows a deeper understanding of individual behaviors. Without it, theoretical models could not be adequately tested.