The Federal Reserve and the Financial Crisis
March 28th, 2015
Elizabeth Turra Brouwer
The Federal Reserve and the financial crisis
The book "The Federal Reserve and the Financial Crisis” contains 4 lectures given by Ben Bernanke, chairman of the U.S. Federal Reserve at George Washington University in March 2012. In this book he explains the type of actions taken by the Fed during the worst financial crisis since the Great Depression, the crisis of 2008-2009. The main idea of this book is to explain that the Fed has learned from its past mistakes and the causes that led it to them. The book is very good written and it explains his ideas clearly. After each lecture there is a question and answer section and the book is basically divided into two parts. The first two provide a background to the last two lectures who focus on how the Fed dealt with the crisis and the recovery. The author starts by talking about the origins and evolution of central banks. He explains how the central bank is not a regular bank; it’s a government agency, and it stands at the center of a country's monetary financial system. There are exceptions where they have currency union, where a number of countries share a central bank, like the European Central Bank that share the euro as their common currency. He explains that central banks have two main missions; the first is to try to achieve macroeconomic stability and to maintain financial stability. The tools the central bank uses to achieve these two objectives. On the economic stability side, the main tool is monetary policy. They can raise or lower short-term interest rates by buying and selling securities in the open market. The other tool for dealing with financial panics or financial crises is the provision of liquidity. In order to address financial stability concerns, one thing they do is make short term loans to financial institutions, these can help calm the market and its called "lender of last resource". There is a third tool that most central banks have, which is financial regulation and supervision. Trying to keep the financial system healthy so that the chance of a financial crisis occurring in the first place is reduced. Central banks have been around for a very long time. The swedes set up a central bank in 1668 and the bank of England was founded in 1694. He also talks about how financial panic is sparked by a loss of confidence in an institution and panics can be very serious problems, if one bank is having problems, people at the bank next door may begin to worry as well. A financial panic can occur anytime you have an institution that has longer-term liquid assets and is financed on the other side of the balance sheet by shot term liabilities such as deposits. The Federal Reserve was founded in 1914 and both concerns about macroeconomic stability and financial stability motivated this decision to create it. After the Civil War there was no central bank, so any kind of financial stability functions that could not be performed by the treasury had to be done privately. Financial panics in the U.S. were a big problem in the period of the restoration of the gold stander after the Civil War in 1879 through the founding of the Federal Reserve. After the crisis of 1907, Congress began to think that maybe they needed a government agency that could address the problem of financial panics. So a 33-volume study was prepared for the Congress about Central banking practices, and Congress moved toward creating then a central bank in 1914. For most of the period from after the civil War until the 1930s, the U.S. was on gold standard, which is a monetary system in which the value of the currency is fixed in terms of gold. Unfortunately gold standard was far from a perfect monetary system. Volatility in output variability and year-to-year movements in inflation were much greater under the gold standard. There were many things wrong with the gold...
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