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Is the Discount Window Necessary? A Penn-Central Perspective

Calomiris, Charles W.

In recent years, economists have come to question the desirability of granting banks the privilege of borrowing from the Federal Reserve’s discount window. The discount window’s detractors cite several disadvantages. First, the Fed’s control over high-powered money can be hampered. If bank borrowing behavior is hard to predict, open market operations cannot perfectly peg high-powered money, which some economists believe the Fed should do. Second, there are microeconomic concerns about potential abuse of the discount window (Schwartz 1 1992). Critics argue that the discount window has been misused as a transfer scheme to hail out (or postpone the failure of) troubled or insolvent financial institutions that should be closed quickly to prevent desperate acts of fraud or excess risk taking by bank management. In response to growing criticism of Fed lending to prop up failing banks, Congress mandated limits on discount lending to distressed banks, which went into effect on December 19, 1993.

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Federal Reserve Bank of St. Louis Review

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September 13, 2011