The Federal Reserve and Financial Regulation: The First Hundred Years

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 (LOLR). 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 LOLR, with the latter role weakened further by stigma. The Fed was unable to prevent the recent crisis, during which its LOLR function expanded significantly. As the Fed begins its second century, there are still great challenges to fulfilling its original intention of panic prevention.

Finance, farms, and the Fed's early years

“…Low interest rates also fueled growth in bank lending. Member banks used the Fed's discount window for long-term borrowing, contrary to its intentions (Gorton and Metrick (2013)). Much of this credit went to the agricultural sector, as the government encouraged farmers to expand production (Sage (1983)).…”

Central Bank Design

“…There are many other design issues that were not addressed, especially concerning financial regulation, a topic that is covered in another paper in this symposium and elsewhere (Gorton and Metrick, 2013;Blinder, 2010). The broader message of this paper is that designing a central bank is not just a worthwhile research question, but also one that can be answered scientifically.…”