The Fed responds to the terrorist attacks of September 11, 2001

When the Fed was founded, its primary purpose was to provide discounted loans to banks suffering from deposit withdrawals. Today, discount loans have become relatively less important in Fed operations. For example, the average weekly amount of discount loans outstanding in 2001 through 9/11 was only $34 million. Still, discount loans remain an effective way for the Fed to make funds available to banks quickly in an emergency. Banks can use these funds to provide cash or loans to households and businesses. The day after the September 11, 2001 terrorist attacks in New York, Washington, D.C. and Pennsylvania, the Federal Reserve provided massive discounted loans to banks. Discount loans increased from $99 million on September 5 to $45.5 billion on September 12, or 500 times their normal level. In the end, households and businesses did not withdraw excessive amounts from their bank accounts after the attacks, and the volume of discount loans returned to normal levels very quickly. By September 19, discount loans had fallen to $2.6 billion, and by September 26, they had fallen to just $20 million. The Federal Reserve also relied on discount lending to protect the banking and financial systems from potential instability during the subprime mortgage crisis of 2007 and 2008. Although the modern Fed focuses on its goals of inflation and economic growth, which it implements through open market operations, it still retains its original purpose of dealing with possible financial panics. To do this, discount loans can be an effective tool. Source: Federal Reserve Board of Governors, Statistical Release H.4.1, various weekly editions.

Ask

Some economists and members of Congress have argued that because of deposit insurance, bank runs and panics no longer occur, and the Federal Reserve no longer needs to act as a lender of last resort. Therefore, the Federal Reserve Act must be amended to eliminate the Federal Reserve's ability to make loans at a discount. Briefly evaluate this argument.

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