Note: This is post #121 in a weekly video series on basic economics.
If you heard a rumor that your bank was insolvent, asks economist Alex Tabarrok, what would you do?
As Tabarrok says, a typical reaction is to panic. And if you can’t get your money out, your next step would likely be to try and get all of your cash in hand. The rumor could even be false, but if enough people responded as if it were true, it would still spell trouble. Even solvent banks can have illiquid assets. If the bank can’t pay out to its depositors, the panic can spread.
This is where the Federal Reserve System comes into play. This video by Marginal Revolution University explains how the Fed can act as the “lender of last resort” in times of financial panic.
(If you find the pace of the videos too slow, I’d recommend watching them at 1.5 to 2 times the speed. You can adjust the speed at which the video plays by clicking on “Settings” (the gear symbol) and changing “Speed” from normal to 1.25, 1.5 or 2.)
Click here to see other videos in the Introduction to Economics series.