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Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Contagion Risk?
Author(s) -
CARLSON MARK,
WHEELOCK DAVID C.
Publication year - 2018
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12520
Subject(s) - solvency , interbank lending market , market liquidity , lender of last resort , vulnerability (computing) , psychological resilience , monetary economics , financial system , business , economics , systemic risk , resilience (materials science) , affect (linguistics) , monetary policy , central bank , financial crisis , macroeconomics , psychology , computer security , computer science , psychotherapist , physics , thermodynamics , linguistics , philosophy
The Federal Reserve System was established to supplant the private interbank system, which was widely seen as a source of instability. We examine how the Fed's presence affected the interbank system's resilience to solvency and liquidity shocks and whether those shocks might have been contagious. The interbank system became more resilient to solvency shocks but less resilient to liquidity shocks as banks sharply reduced their liquid assets after the Fed's founding. The industry's response illustrates how the introduction of a lender of last resort can alter private behavior in ways that increase the likelihood that the lender will be needed.