The Fed plays an important role in maintaining market confidence. As former Chairman Alan Greenspan put it in a 1997 address: “In [financial crises] the Federal Reserve stands ready to provide liquidity, if necessary. . . . The objectives of the central bank in crisis management are to . . . prevent a contagious loss of confidence.” [emphasis added]
Just by standing ready to provide loans to banks in an emergency, the Fed can often prevent emergencies from happening in the first place. In each of the following examples how does the fact that someone or something stands ready to cure the bad outcome help prevent the bad outcome from ever happening in the first place?
a. A security guard stands inside a bank.
b. Federal agents guard Fort Knox, where about one-half of the U.S. government’s gold is stored.
c. The Federal Reserve promises to insure almost 100% of bank deposits.
d. Police, worried about possible riots during spring break in Palm Springs, California, bring in police from other cities.