Principles of Economics- Mankiw (5th) 601

Principles of Economics- Mankiw (5th) 601 - CHAPTER 27 T H...

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CHAPTER 27 THE MONETARY SYSTEM 621 system, which in turn reduces the money supply. Conversely, a lower discount rate encourages bank borrowing from the Fed, increases the quantity of reserves, and increases the money supply. The Fed uses discount lending not only to control the money supply but also to help financial institutions when they are in trouble. For example, in 1984, ru- mors circulated that Continental Illinois National Bank had made a large number of bad loans, and these rumors induced many depositors to withdraw their de- posits. As part of an effort to save the bank, the Fed acted as a lender of last resort and loaned Continental Illinois more than $5 billion. Similarly, when the stock market crashed on October 19, 1987, many Wall Street brokerage firms found themselves temporarily in need of funds to finance the high volume of stock trad- ing. The next morning, before the stock market opened, Fed Chairman Alan Greenspan announced the Fed’s “readiness to serve as a source of liquidity to sup-
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