TY - JOUR AU - Bernstein,Asaf AU - Hughson,Eric AU - Weidenmier,Marc D. TI - Can a Lender of Last Resort Stabilize Financial Markets? Lessons from the Founding of the Fed JF - National Bureau of Economic Research Working Paper Series VL - No. 14422 PY - 2008 Y2 - October 2008 UR - http://www.nber.org/papers/w14422 L1 - http://www.nber.org/papers/w14422.pdf N1 - Author contact info: Asaf Bernstein Harvey Mudd College 500 East Ninth Street Claremont, CA 91711 E-Mail: abernstein@hmc.edu Eric Hughson Leeds School of Business University of Colorado Building #4, UCB 419 Boulder, Colorado 80309-0419 E-Mail: eric.hughson@colorado.edu Marc D. Weidenmier Robert Day School of Economics and Finance Claremont McKenna College 500 East Ninth Street Claremont, CA 91711 Tel: 909/607-8497 Fax: 909/621-8249 E-Mail: marc_weidenmier@claremontmckenna.edu AB - We use the founding of the Federal Reserve as a historical experiment to provide some insight into whether a lender of last resort can stabilize financial markets. Following the Panic of 1907, Congress passed two measures that established a lender of last resort in the United States: (1) the Aldrich-Vreeland Act of 1908 which authorized certain banks to issue emergency currency during a financial crisis and (2) the Federal Reserve Act of 1913 which established a central bank. We employ a new identification strategy to isolate the effects of the introduction of a lender of last resort from other macroeconomic shocks. We compare the standard deviation of stock returns and short-term interest rates over time across the months of September and October, the two months of the year when financial markets were most vulnerable to a crash because of financial stringency from the harvest season, with the rest of the year during the period 1870-1925. Stock volatility in the post-1907 period (June 1908-1925) was more than 40 percent lower in the months of September and October compared to the period (1870- May 1908). We also find that the volatility of the call loan rate declined nearly 70 percent in September and October following the monetary regime change. ER -