Fed in Print

Abstract

As a result of legal restrictions on branch banking, an extensive interbank system developed in the United States during the 19th century to facilitate interregional payments and flows of liquidity and credit. Vast sums moved through the interbank system to meet seasonal and other demands, but the system also transmitted shocks during banking panics. The Federal Reserve was established in 1914 to reduce reliance on the interbank market and correct other defects that caused banking system instability. Drawing on recent theoretical work on interbank networks, we examine how the Fed’s establishment affected the system’s resilience to solvency and liquidity shocks and whether these shocks might have been contagious. We find that the interbank system became more resilient to solvency shocks but less resilient to liquidity shocks as banks sharply reduced their liquidity after the Fed’s founding. The industry’s response illustrates how the introduction of a lender of last resort can alter private behavior in a way that increases the likelihood that the lender will be needed.

Mark A. Carlson & David C. Wheelock, Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Systemic Risk?, Board of Governors of the Federal Reserve System (U.S.), Finance and Economics Discussion Series 2016-059, 18 Jul 2016.

JEL Classification:

E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
N11 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - U.S.; Canada: Pre-1913
N12 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - U.S.; Canada: 1913-
N21 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: Pre-1913
N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

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