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We study the fragility of discretionary liquidity provision by
major financial intermediaries during systemic events. The
laboratory of our study is the recent collapse of the auction rate
securities (ARS) market. Using a comprehensive dataset constructed
from auction reports and intraday transactions data on municipal
ARS, we present quantitative evidence that auction dealers acted at
their own discretion as "market makers" before the market
collapsed. We show that this discretionary liquidity provision
greatly affected both net investor demand and auction clearing
rates. Importantly, such discretionary liquidity provision is
fragile. As auction dealers suffered losses from other financial
markets and faced increasing inventory pressure, they stopped
making markets. Moreover, the drop in support occurred suddenly,
apparently triggered by the unexpected withdrawal of one major
broker-dealer.
It is commonly supposed in public and academic discourse that
inflation and big government are related. We show that economic
theory delivers such a prediction only in special cases. As an
empirical matter, inflation is significantly positively related to
the size of government mainly when periods of war and peace are
compared. We find a weak positive peacetime time series correlation
between inflation and the size of government and a negative
cross-country correlation of inflation with non-defense spending.
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