WHAT WOULD BAGEHOT DO?

WHAT WOULD BAGEHOT DO? What should the Federal Reserve do in response to the current financial crisis? It is appropriate to link to an article in The Economist to answer the question because Walter Bagehot, the greatest editor of the Economist, gave the answer in 1866. His policy prescription is still accepted. The central bank (the Federal Reserve) should act as a lender of last resort. It should lend “quickly, freely and readily” at a penalty rate of interest….. That is the guideline for what the European and American central banks are doing. The “penalty rate of interest” presents problems of application. The underlying idea is that the central bank does not want to bail out the reckless, which would encourage recklessness in the future.