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Rethinking the Lender of Last Resort: New Evidence on the Stabilization of Money Markets Before the Federal Reserve
CEPR
2024.05.20
Short-term funding markets play a vital role in financial stability. Frequent liquidity shocks caused severe interest rate instability during financial crises historically; a problem commonly thought solved by the creation of the Federal Reserve (Fed) in 1913-4. On the contrary, this paper provides novel evidence that interest rates stabilized six years earlier, with the introduction of federal legislation for a national lender of last resort mechanism in January 1908. The results show that creation of the Fed generated little additional impact on funding market rates or on short-term credit spreads. Moreover, the newly-founded Fed did not succeed in its efforts to shift banks away from overnight lending in the stock market as the market boomed after World War I.