DP16490 Financial Stability Policies and Bank Lending: Quasi-experimental Evidence from Federal Reserve Interventions in 1920-1921

Author(s): Kilian Rieder
Publication Date: August 2021
Keyword(s): bank lending, Credit boom, Federal Reserve System, leaning against the wind, leverage, macroprudential policy, monetary policy, progressive discount rate, recession of 1920/1921
JEL(s): E52, E58, N12, N22
Programme Areas: Economic History, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16490

I exploit a single natural experiment to estimate the comparative causal effects of different financial stability policies on bank-level credit. In 1920, four Federal Reserve Banks hiked their interest rate indiscriminately to safeguard financial stability. Another four Reserve Banks employed targeted rate action aimed at over-leveraged banks instead. For identification, I draw on border regression discontinuities with the remaining Federal Reserve districts which did not change their stance. The uniform rate hike had counterproductive effects, whereas targeted policy caused credit to contract significantly. The relative strengths of the bank-lending and risk-shifting channels of monetary policy explain these differential outcomes.