Question

The Fed learned some critical lessons from the Great Depression about how to best respond to the 2008 financial crisis in terms what action to take and which actions not to take.   Name one action or lesson they applied in 2008 that they did not in the crash of 1929, and why? (short answer)

Answer 1

Answer: The one action or lesson they applied in 2008 that they did not in the crash of 1929 is that during the Depression, Fed officials interpreted low levels of discount window borrowing as indicating that banks had no need for additional liquidity. Officials seem to have ignored the possibility that

(i) banks were reluctant to borrow due to concern that anxious depositors would interpret a bank’s borrowing from the discount window as a sign of weakness or

(ii) that many banks were unable to borrow because they lacked eligible collateral.

By contrast, during the crisis of 2007-09, Fed officials acted quickly to encourage banks to borrow from the Fed—first by issuing a statement that the discount window was available to meet the liquidity needs of banks, then by reducing the primary credit rate and increasing the maximum term of discount window loans, and finally by introducing the TAF to provide an anonymous source of term funds without any of the stigma associated with discount window borrowing.