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

  • Gary Gorton
  • Andrew Metrick
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    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.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.27.4.45
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    File URL: http://www.aeaweb.org/jep/ds/2704/2704-0045_ds.zip
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    Article provided by American Economic Association in its journal Journal of Economic Perspectives.

    Volume (Year): 27 (2013)
    Issue (Month): 4 (Fall)
    Pages: 45-64

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    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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    1. Adam B. Ashcraft & Morten L. Bech & W. Scott Frame, 2008. "The Federal Home Loan Bank System: the lender of next-to-last resort?," Staff Reports 357, Federal Reserve Bank of New York.
    2. Michael J. Fleming & Warren B. Hrung & Frank M. Keane, 2010. "Repo Market Effects of the Term Securities Lending Facility," American Economic Review, American Economic Association, vol. 100(2), pages 591-96, May.
    3. repec:cup:cbooks:9780521562614 is not listed on IDEAS
    4. Gary Gorton & Andrew Metrick, 2010. "Regulating the Shadow Banking System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 41(2 (Fall)), pages 261-312.
    5. Butkiewicz James L., 1995. "The Impact of a Lender of Last Resort during the Great Depression: The Case of the Reconstruction Finance Corporation," Explorations in Economic History, Elsevier, vol. 32(2), pages 197-216, April.
    6. Fishe, Raymond P H & Wohar, Mark, 1990. "The Adjustment of Expectations to a Change in Regime: Comment," American Economic Review, American Economic Association, vol. 80(4), pages 968-76, September.
    7. Wicker, Elmus, 1980. "A Reconsideration of the Causes of the Banking Panic of 1930," The Journal of Economic History, Cambridge University Press, vol. 40(03), pages 571-583, September.
    8. Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," Center for Financial Institutions Working Papers 02-29, Wharton School Center for Financial Institutions, University of Pennsylvania.
    9. Warren B. Hrung & Jason S. Seligman, 2011. "Responses to the financial crisis, treasury debt, and the impact on short-term money markets," Staff Reports 481, Federal Reserve Bank of New York.
    10. Gary B. Gorton & Andrew Metrick, 2009. "Securitized Banking and the Run on Repo," NBER Working Papers 15223, National Bureau of Economic Research, Inc.
    11. Michael D. Bordo & David C. Wheelock, 2011. "The promise and performance of the Federal Reserve as Lender of Last Resort 1914-1933," Working Paper 2011/01, Norges Bank.
    12. Wheelock, David C, 1990. "Member Bank Borrowing and the Fed's Contractionary Monetary Policy during the Great Depression," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(4), pages 409-26, November.
    13. Anat Admati & Martin Hellwig, 2013. "The Bankers' New Clothes: What's Wrong with Banking and What to Do about It," Economics Books, Princeton University Press, edition 1, volume 1, number 9929.
    14. James L. Butkiewicz, 1999. "The Reconstruction Finance Corporation, the Gold Standard, and the Banking Panic of 1933," Southern Economic Journal, Southern Economic Association, vol. 66(2), pages 271-293, October.
    15. Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867-1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1, December.
    16. Clark, Truman A, 1986. "Interest Rate Seasonals and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 76-125, February.
    17. Timberlake, Richard H, Jr, 1984. "The Central Banking Role of Clearinghouse Associations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(1), pages 1-15, February.
    18. Gorton, Gary, 1985. "Clearinghouses and the Origin of Central Banking in the United States," The Journal of Economic History, Cambridge University Press, vol. 45(02), pages 277-283, June.
    19. Walker F. Todd, 1992. "History of and rationales for the Reconstruction Finance Corporation," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 22-35.
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