The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
The Outreach & Education function engages, empowers and educates the public in the Second District. Our outreach mission furthers the Bank’s commitment to the region by listening to the communities we serve and developing programs, analysis and sponsored conferences and clinics to help meet their needs. Our education mission aims to advance public knowledge about the Federal Reserve System and its role in the economy.
In a 1999 paper, Freeman proposes a model in which discount window lending and open market operations have different outcomes—an important development because in most of the literature the results of these policy tools are indistinguishable. Freeman’s conclusion that the central bank should absorb losses related to default to provide risk-sharing goes against the concern that central banks should limit their exposure to credit risk. We extend Freeman’s model by introducing moral hazard. With moral hazard, the central bank should avoid absorbing losses, contrary to Freeman’s argument. However, we show that the outcomes of discount window lending and open market operations can still be distinguished in this new framework. The optimal policy would be for the central bank to make a restricted number of creditors compete for funds. By restricting the number of agents, the central bank can limit the moral hazard problem. And by making agents compete with each other, the central bank can exploit market information that reveals the state of the economy.