A Black Swan in the Money Market

38 Pages Posted: 17 Apr 2008 Last revised: 6 Feb 2021

See all articles by John B. Taylor

John B. Taylor

Stanford University; National Bureau of Economic Research (NBER)

John C. Williams

Federal Reserve Bank of New York

Date Written: April 2008


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.

Suggested Citation

Taylor, John B. and Williams, John C., A Black Swan in the Money Market (April 2008). NBER Working Paper No. w13943, Rock Center for Corporate Governance Working Paper No. 33, Available at SSRN: https://ssrn.com/abstract=1121734

John B. Taylor (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

John C. Williams

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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