had two immediate consequences: They took an enormous human toll and they created a potentially serious crisis for the economy through their impact on financial markets. The Federal Reserve reacted to the potential economic crisis by providing an unusual amount of liquidity and reducing the federal funds rate more than would be expected from levels of output and inflation. This was not the first time, however, that the Federal Reserve responded quickly and forcefully to unusual conditions in financial markets that threatened to spill over to the real economy. Indeed, the September 11th attacks reminded us that problems in financial markets can disrupt the whole economic system. This article describes the Federal Reserve’s reactions to crises, or potential crises, in financial markets. The crises considered are periods of sudden revision in expectations or physical disruption that threaten the stability of the economic system through asset price volatility. The Federal Reserve has responded to financial crises in three main ways: (i) The Fed has provided immediate liquidity through open market operations, discount window lending, and regulatory forbearance; (ii) the Fed has lowered the federal funds target over the medium term; (iii) the Fed has participated in foreign exchange intervention with the U.S. Treasury. The next section of the article explains how sudden changes in asset prices or asset price uncertainty spill over into the rest of the economy. Next, the article explains how the Federal Reserve Bank can use its tools to help minimize the impact of the uncertainty and physical disruptions of crises. Finally, several recent episodes—the stock market crash of 1987, the Russian default, and the September 11th attacks—are examined as case studies
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