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Journal of Economic Perspectives: Vol. 27 No. 4 (Fall 2013)

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

Article Citation

Gorton, Gary, and Andrew Metrick. 2013. "The Federal Reserve and Panic Prevention: The Roles of Financial Regulation and Lender of Last Resort." Journal of Economic Perspectives, 27(4): 45-64.

DOI: 10.1257/jep.27.4.45

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.

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Authors

Gorton, Gary (Yale U)
Metrick, Andrew (Yale U)

JEL Classifications

E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy
E52: Monetary Policy
E58: Central Banks and Their Policies
G21: Banks; Depository Institutions; Micro Finance Institutions; Mortgages
G28: Financial Institutions and Services: Government Policy and Regulation

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