What the Fed Can (and Can't) Do

There are limits to what control central banks have.

When markets went bonkers over the summer, central banks around the world, led by our own Federal Reserve, came to the rescue. Government banks are indeedpowerful institutions, but there are limits to what they can and cannot control.

Central banks can stop a run on the banking system. A run occurs when depositors try to withdraw money but discover that a bank doesn't have enough reserves to satisfy all its customers. Central banks can stop runs by supplying reserves to the banking system. We saw this power in action recently when the Bank of England lent billions of pounds to Northern Rock, a savings bank holding devalued subprime mortgages. As British depositors gained confidence that the central bank would make them whole, they stopped their run on Northern Rock.

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Jeremy J. Siegel
Contributing Columnist, Kiplinger's Personal Finance
Siegel is a professor at the University of Pennsylvania's Wharton School and the author of "Stocks For The Long Run" and "The Future For Investors."