Peter C. McCluskey, <firstname.lastname@example.org>, writes:
> If the Fed loans banks unlimited amounts of cash with little regard to
> the bank's ability to repay the loans, then they can fairly reliably
> prevent runs on the banks before Jan. 1. But that strategy will probably
> cause significant inflation, inflation, and invite a repeat of the kind
> of recklessness that produced the worst of the S&L failures, so the Fed
> will be hesitant to act as if runs are likely without clear evidence of
> an imminent panic.
I don't see why it would cause inflation. The money supply would not increase. All that happens is that there is a transfer from bank balances to cash holdings. The total money in anyone's possession does not change.
In fact, it is likely that in such a time of economic uncertainty people would want to increase their total savings (cash plus bank accounts). This is a common response to hard times. People want to build up a savings "buffer" in case they lose their jobs or face other economic problems.
If total savings increase, this actually reduces the velocity of money and can cause deflation. People are spending less and so prices drop.
Some people have suggested that the opposite would happen, that having withdrawn cash people would want to spend it, and save less. This could be either for psychological reasons (cash invites spending) or perhaps to spend money on Y2K related supplies (generators, food, water, etc.). It's possible that this would happen to some extent, but I would expect that the traditional response of cutting expenses during hard times will still dominate.
In addition, in any such bank-run environment, there is probably a sharp fall in stock prices. This is a great loss of paper wealth and makes people feel poorer, which will also tend to decrease spending and cause deflation.