20.3 Conclusion

Throughout history, financial crises have been a major source of economic fluctuations and a main driver of economic policy. In 1873 Walter Bagehot published a celebrated book called Lombard Street about how the Bank of England should manage a financial crisis. His recommendation that it should act as a lender of last resort has over time become the conventional wisdom. In 1913, in the aftermath of the banking panic of 1907, Congress passed the act establishing the Federal Reserve. Congress wanted the new central bank to oversee the banking system in order to ensure greater financial and macroeconomic stability.


The Fed has not always been successful in accomplishing this goal. To this day, many economists believe that the Great Depression was so severe because the Fed failed to follow Bagehot’s advice and act as lender of last resort. If it had acted more aggressively, the crisis of confidence in the banks and the resulting collapse in the money supply and aggregate demand might have been averted. Mindful of this history, the Fed played a much more active role in trying to mitigate the impact of the financial crisis of 2008–2009.

Following a crisis, it is easy to lament the problems caused by the financial system, but we should not lose sight of the great benefits that the system brings. The financial system gives savers the ability to earn the best possible rate of return at the lowest possible risk. It gives entrepreneurs the ability to fund their ideas for new business ventures. By bringing together those who want to save and those who want to invest, the financial system promotes economic growth and overall prosperity.