The Crisis of 1998 and the Role of the Central Bank

A key mission of the U.S. Federal Reserve System is to safeguard the economy against systemic financial crises. This concern with financial crises stems from a long-held belief that they are associated with declines in economic activity. In the U.S., there is clear evidence that financial panics and recessions are somehow related (Mishkin, 1991). In the case of the Great Depression, Bernanke (1983) argues that the disruption in financial intermediation transformed a severe downturn into a .protracted depression.. More recently, the Asian financial crisis in 1997 was followed by sharp declines in economic activity. (Indonesia, Korea, Thailand, and Malaysia all experienced two-quarter declines in gross domestic product [GDP] of over 12 percent.) This historical record has led to a pervasive belief that systemic crises in the financial sector have consequences that are far more than sectoral. Rather, they appear to affect the entire economy, perhaps through the unique role played by financial intermediation.