The Costs and Benefits of Shrinking the Fed’s Discount Window

Most central banks share at least one common element in their design, the ability to serve as a Lender of Last Resort to banks, and sometimes, other financial institutions. By having this power, central banks can maintain credit flows to the financial system when the private sector, or other government entities, are unable or unwilling to provide credit. During the 2008–2009 Financial Crisis, the Fed provided massive flows of credit to a wider variety of financial institutions and businesses than it had ever done in its prior 93-year history. This likely shortened and reduced the impact of the Great Recession. However, the Fed’s actions essentially made it appear to be the fourth branch of government that usurped the prerogatives and authorities of the Legislative Branch. In writing the Dodd– Frank Act, an angry and jealous U.S. Congress sought to curtail the Fed’s abilities to serve as Lender of Last Resort in the future. In the name of ending bailouts and reducing moral hazard, the Congress has essentially eliminated the Fed’s abilities to serve as First Responder in the next financial panic. This sets a dangerous precedent, akin to eliminating fire departments and emergency medical teams. The Fed’s duties as First Financial Responder need to be restored long before the next financial crisis.