Wednesday, March 07, 2007

The purpose of the Federal Reserve system

Excellent historical analysis at Econbrowser of why the Federal Reserve system was created and how it has reduced the incidence of financial crises in the US...a quote:

"If you're a smaller country like Korea for which a lot of the short-term debt is denominated in dollars, your central bank does not have the power to create extra dollars if everybody suddenly demands their payment and refuses to extend credit. Trying to flood the market with more of your own currency is just going to make the outflow of capital more severe."

One can see from the chart provided that short-term volatility in commercial paper rates decreased significantly after the creation of the Federal Reserve. In my view this has been beneficial for the US economy as it reduced the variability in access to working capital for businesses.

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