Bernanke is a fan of Walter Bagehot’s advice to lend very freely (at a penalty rate) when there is a money crisis. But he takes it one step further. He argues that the Fed does not even have to lend at a penalty rate because it has no constraint on the creation of liquid assets. This is the theory that he is following. (1) It leads to completely irresponsible credit creation by the Fed with none of the usual disciplines from lenders. (2) The incentive for the rest of us to save and supply credit is undermined because we cannot … Continue reading Following Bagehot’s advice