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The Federal Reserve and Panic Prevention: The Roles of Financial Regulation and Lender of Last Resort

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  • Gary Gorton
  • Andrew Metrick

Abstract

This paper surveys the role of the Federal Reserve within the financial regulatory system, with particular attention to the interaction of the Fed's role as both a supervisor and a lender-of-last-resort. The institutional design of the Federal Reserve System was aimed at preventing banking panics, primarily due to the permanent presence of the discount window. This new system was successful at preventing a panic in the early 1920s, after which the Fed began to discourage the use of the discount window and intentionally create "stigma" for window borrowing -- policies that contributed to the panics of the Great Depression. The legislation of the New Deal era centralized Fed power in the Board of Governors, and over the next 75 years the Fed expanded its role as a supervisor of the largest banks. Nevertheless, prior to the recent crisis the Fed had large gaps in its authority as a supervisor and as lender of last resort, with the latter role weakened further by stigma. The Fed was unable to prevent the recent crisis, during which its lender of last resort function expanded significantly. As the Fed begins its second century, there are still great challenges to fulfilling its original intention of panic prevention.

Suggested Citation

  • Gary Gorton & Andrew Metrick, 2013. "The Federal Reserve and Panic Prevention: The Roles of Financial Regulation and Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 27(4), pages 45-64, Fall.
  • Handle: RePEc:aea:jecper:v:27:y:2013:i:4:p:45-64
    Note: DOI: 10.1257/jep.27.4.45
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Michael D. Bordo, 2017. "An Historical Perspective on the Quest for Financial Stability and the Monetary Policy Regime," Economics Working Papers 17108, Hoover Institution, Stanford University.
    2. Jacobson, Margaret M. & Tallman, Ellis W., 2015. "Liquidity provision during the crisis of 1914: Private and public sources," Journal of Financial Stability, Elsevier, vol. 17(C), pages 22-34.
    3. Masciandaro, Donato & Romelli, Davide, 2015. "Ups and downs of central bank independence from the Great Inflation to the Great Recession: theory, institutions and empirics," Financial History Review, Cambridge University Press, vol. 22(03), pages 259-289, December.
    4. Donato Masciandaro & Davide Romelli, 2015. "Ups and Downs. Central Bank Independence from the Great Inflation to the Great Recession: Theory, Institutions and Empirics," BAFFI CAREFIN Working Papers 1503, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    5. Gabriel P. Mathy & Matthew Jaremski, 2016. "How Was the Quantitative Easing Program of the 1930s Unwound?," Working Papers 2016-01, American University, Department of Economics.
    6. Carlson, Mark A. & Duygan-Bump, Burcu & Nelson, William R., 2015. "Why Do We Need Both Liquidity Regulations and a Lender of Last Resort? A Perspective from Federal Reserve Lending during the 2007-09 U.S. Financial Crisis," Finance and Economics Discussion Series 2015-11, Board of Governors of the Federal Reserve System (U.S.).
    7. Krug, Sebastian & Wohltmann, Hans-Werner, 2016. "Shadow banking, financial regulation and animal spirits: An ACE approach," Economics Working Papers 2016-08, Christian-Albrechts-University of Kiel, Department of Economics.
    8. Koulischer, François & Struyven, Daan, 2014. "Central bank liquidity provision and collateral quality," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 113-130.
    9. repec:eee:dyncon:v:81:y:2017:i:c:p:50-64 is not listed on IDEAS
    10. Charles W. Calomiris & Matthew Jaremski & Haelim Park & Gary Richardson, 2015. "Liquidity Risk, Bank Networks, and the Value of Joining the Federal Reserve System," NBER Working Papers 21684, National Bureau of Economic Research, Inc.
    11. Michael D. Bordo & Christopher M. Meissner, 2015. "Growing Up to Stability? Financial Globalization, Financial Development and Financial Crises," NBER Working Papers 21287, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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