Can a Lender of Last Resort Stabilize Financial Markets? Lessons from the Founding of the Fed / Asaf Bernstein, Eric Hughson, Marc D. Weidenmier.

Format:

Book

Author/Creator:

Bernstein, Asaf.

Contributor:

National Bureau of Economic Research.

Hughson, Eric.

Weidenmier, Marc D.

Series:

Working Paper Series (National Bureau of Economic Research) no. w14422.

NBER working paper series no. w14422

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2008.

Summary:

We use the founding of the Federal Reserve as a historical experiment to provide some insight into whether a lender of last resort can stabilize financial markets. Following the Panic of 1907, Congress passed two measures that established a lender of last resort in the United States: (1) the Aldrich-Vreeland Act of 1908 which authorized certain banks to issue emergency currency during a financial crisis and (2) the Federal Reserve Act of 1913 which established a central bank. We employ a new identification strategy to isolate the effects of the introduction of a lender of last resort from other macroeconomic shocks. We compare the standard deviation of stock returns and short-term interest rates over time across the months of September and October, the two months of the year when financial markets were most vulnerable to a crash because of financial stringency from the harvest season, with the rest of the year during the period 1870-1925. Stock volatility in the post-1907 period (June 1908-1925) was more than 40 percent lower in the months of September and October compared to the period (1870- May 1908). We also find that the volatility of the call loan rate declined nearly 70 percent in September and October following the monetary regime change.

Notes:

Print version record

October 2008.