The Initial Policy Response

  • Daniel Aronoff


After the bankruptcy of Lehman and the takeover of AIG in mid-September 2008, fear began to spread like wildfire. Corporations and households massively increased their demand for liquid assets. Keynes vividly described the motive behind the rush to liquidity that seizes markets in the aftermath of a huge negative shock to expectations:

Our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. Even though this feeling about Money is itself conventional or instinctive, it operates, so to speak, at a deeper level of our motivations. It takes charge at the moments when the higher, more precarious conventions have weakened. The possession of actual money lulls our sense of disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude.2

The increase in the “premium which we require to make us part with money” was reflected in a decline in demand for all goods and assets other than money, which created downward pressure on all prices. The panicked rush to acquire liquid assets actually reduced liquidity in the economy. To understand why, I need to explain a bit more about the concept of liquidity. Keynes wrote that one asset is more liquid than another if it is “more certainly realizable at short notice without loss.”3 In normal times, there is a spectrum of liquidity and different assets have greater or lesser degrees of it, money being the most liquid asset.


Financial Crisis Commercial Bank Bank Loan Bank Lending Liquid Asset 
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  1. 12.
    Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton University Press, 1963), pp. 356–357.Google Scholar
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    Ben S. Bernanke, “On Milton Friedman’s Ninetieth Birthday,” Remarks at the Conference to Honor Milton Friedman, University of Chicago, November 8, 2002.Google Scholar
  3. 21.
    Milton Friedman, “The Role of Monetary Policy,” The American Economic Review, Vol. 58 (1968): 1–17.Google Scholar
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    Kathleen Kahle and Renee Stultz, “Access to Capital, Investment, and the Financial Crisis,” Journal of Financial Economics, Vol. 110 Issue 2 (2013): 280–299.CrossRefGoogle Scholar
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    Victoria Ivashina and David Scharfstein, “Bank Lending during the Financial Crisis of 2008,” Journal of Financial Economics, Vol. 97 (2010): 319–338.CrossRefGoogle Scholar

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© Daniel Aronoff 2016

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  • Daniel Aronoff

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