The 2007-2009 Financial crisis left significant wounds on the American financial system. After 10% unemployment and over 1.5 trillion taxpayer dollars, many undoubtedly continue to question the usefulness and relevance of the Federal Reserve Banking System and its actions in today’s modern banking environment (Gorton and Metrick). Since the Federal Reserve was created in 1913, its mission to increase banking stability through preventive and reactionary policy while promoting economic growth in the American economy has been largely successful. However, after analyzing evidence from both papers, “Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Systemic Risk?” and “The Financial Crisis of 2007-2009,”
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The Federal Reserve was created in 1913—a world vastly different from today—to ensure a more stable monetary and financial system. This includes conducting monetary policy, regulating banks, and evaluating systemic risk. The institution planned to combat three major problems, the first of which included the effects of seasonality shocks caused by regional differences in demand for money, largely do to agriculture cycles. During harvest, money held in central banks (such as New York) was quickly transferred to the Midwest to compensate farmers. As a result, money supply in the East would dramatically fall every year, causing an environment where “interest rates spiked and money market conditions tightened” (Carlson and Wheelock). Of course, this phenomena, which occurred every year like clockwork, was not healthy for the economy—and thus a reason the Fed was born. The insertion of the Federal Reserve allowed the balance sheets of banks to expand and contract seasonally, by affording them a line of credit through the discount window, and solved the issue of disproportionate money demand (Carlson and Wheelock). This application of the Federal Reserve would prove beneficial for both rural and urban Americans, while complementing an economy largely influenced by …show more content…
In short, the problem of inelastic currency existed from the beginning of the U.S. banking system due to the use of the gold standard, which resulted in a shortage of currency within the interbanking system. Because of a fixed aggregate supply of money, regions in which demand for money was high during specific times of the year or in situations of economic shock would experience increased economic stress in the form of higher interest rates and bank runs, which eventually led to bank failures (Carlson and Wheelock). In this case, the Federal Reserve solved the problem of a fixed supply of money with the introduction of the discount window. Much like with seasonal shocks in demand for money, the discount window allowed member banks of the Federal Reserve to withdraw money for a lower interest rate in order to finance the higher demand. This was regarded as the necessary step to make “banking systems less vulnerable to disturbances from the stock market” and resolve other factors that could disturb the flow of liquid currency (Carlson and Wheelock). As demonstrated, the Federal Reserve was instrumental in reducing the problem of inelastic currency, which resulted in less systemic risk and fewer bank
The Federal Reserve was created in 1913—a world vastly different from today—to ensure a more stable monetary and financial system. This includes conducting monetary policy, regulating banks, and evaluating systemic risk. The institution planned to combat three major problems, the first of which included the effects of seasonality shocks caused by regional differences in demand for money, largely do to agriculture cycles. During harvest, money held in central banks (such as New York) was quickly transferred to the Midwest to compensate farmers. As a result, money supply in the East would dramatically fall every year, causing an environment where “interest rates spiked and money market conditions tightened” (Carlson and Wheelock). Of course, this phenomena, which occurred every year like clockwork, was not healthy for the economy—and thus a reason the Fed was born. The insertion of the Federal Reserve allowed the balance sheets of banks to expand and contract seasonally, by affording them a line of credit through the discount window, and solved the issue of disproportionate money demand (Carlson and Wheelock). This application of the Federal Reserve would prove beneficial for both rural and urban Americans, while complementing an economy largely influenced by …show more content…
In short, the problem of inelastic currency existed from the beginning of the U.S. banking system due to the use of the gold standard, which resulted in a shortage of currency within the interbanking system. Because of a fixed aggregate supply of money, regions in which demand for money was high during specific times of the year or in situations of economic shock would experience increased economic stress in the form of higher interest rates and bank runs, which eventually led to bank failures (Carlson and Wheelock). In this case, the Federal Reserve solved the problem of a fixed supply of money with the introduction of the discount window. Much like with seasonal shocks in demand for money, the discount window allowed member banks of the Federal Reserve to withdraw money for a lower interest rate in order to finance the higher demand. This was regarded as the necessary step to make “banking systems less vulnerable to disturbances from the stock market” and resolve other factors that could disturb the flow of liquid currency (Carlson and Wheelock). As demonstrated, the Federal Reserve was instrumental in reducing the problem of inelastic currency, which resulted in less systemic risk and fewer bank