Although the specifics vary across central banks, the approaches outlined have several important common elements. We each have taken actions to provide more financing at terms longer than overnight. We each have chosen to auction funding against a broader range of collateral, collateral other than government securities, and in our case with a broader set of counterparties. And we have activated swap lines to help the relevant central banks provide liquidity in dollars in their markets.

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The Term Auction Facility gives us a tool that lies somewhere between our open market operations and our primary credit program. It provides a mechanism for expanding the range of collateral against which we provide funds to the market—in effect to change the composition of our balance sheet—in ways we cannot do through traditional open market operations.  And it does this in a way that may be more effective in mitigating a broader marketwide liquidity shortage than does the existing discount window facility, in part because of the perceived stigma in recourse to a facility that has come to be regarded as a source of funds for individual institutions facing a temporary, exceptional need for liquidity. Because the quantity of funds to be injected is known in advance, this mechanism poses fewer complications for our ability to reduce volatility in the fed funds rate around the target.

The Federal Reserve Act gives us broad authority to act in response to these types of conditions. We will continue to examine ways to adapt our instruments as market conditions evolve.  We will do so in close cooperation with other central banks, as indeed we have since August.  And we will do so in the tradition of pragmatism and flexibility that has been one of the defining features of the central bank of the United States.

Between Aug. 10 and Aug. 24, the federal funds rate traded below the FOMC's target rate of 5.25 percent. Dudley said ``there was no stealth easing'' during that period, a reference to some economists' suggestions that the central bank wanted rates lower than it was willing to announce publicly during a credit crisis.

He said banks were anticipating an inter-meeting rate cut, so they were reluctant to bid the fed funds rate up to the target. Also, he said the Fed preferred to miss the target on the low side to avoid adding to market disruptions. 

 ``We definitely wanted to get back to target,'' he said, ``and it took a little bit longer than we wanted.''

As reported by Dow Jones Newswires

Loans through the discount window differ from open market operations in that they can be made directly to specific banks with strong demands for liquidity.  (In contrast, open market operations are arranged with a limited set of dealers of government securities.)  In addition, whereas open market operations typically involve lending against government securities, loans through the discount window can be made against a much wider range of collateral, including mortgages and mortgage-backed securities.  As with open market operations, however, Fed lending through the discount window provides banks with liquidity, not risk capital. In particular, the strong collateralization accompanying discount window credit eliminates essentially all risk for the Federal Reserve System and the taxpayer. Nonetheless, the availability of the discount window is potentially significant for banks, as it gives them greater confidence that they can obtain additional liquidity as necessary. Access to a backstop source of liquidity in turn reduces the incentives of banks to limit the credit they provide to their customers and counterparties.

It's almost gotten to the point where I don't know that we need all this apparatus of open market operations anymore. The chairman can go out and say, "We raised the federal funds rate by a quarter percent today", the market says, "Yes, sir" and up it goes or down it goes and the rest of you can go to sleep.

It should not be too surprising, then, that the Federal Reserve’s response to the Asian financial crisis, like the response to the 1987 stock market crash, was to provide liquidity through open market operations by lowering the federal funds rate target rather than by using the discount window. However, using open market operations rather than the discount window has potential implications for the overall stance of monetary policy. When the Federal Reserve provided extended credit to the banking system in the 1980s and early 1990s, discount window borrowing was generally offset by open market operations to keep overall liquidity in the banking system unchanged. As a result, the stance of monetary policy was kept independent of liquidity provision via the discount window.

In contrast, when the Federal Reserve uses open market operations without the discount window, the stance of monetary policy is changed. This raises two concerns. First, what if the appropriate monetary policy stance conflicts with the need to provide liquidity to individual institutions or to financial markets? Second, if open market operations are used to provide additional liquidity in times of crisis, when is the appropriate time to remove this liquidity to prevent a buildup of inflationary pressures? These are important questions deserving further research and analysis.