COPING WITH a STOCK MARKET CRASH: BLACK MONDAY, 1987

question 96

Multiple Choice

COPING WITH A STOCK MARKET CRASH: BLACK MONDAY, 1987
How did the Fed successfully respond to the major stock market crash in 1987?
On October 19, 1987, known as "Black Monday," the Dow Jones index of the stock market fell a dramatic 22.6 percent in one
day. Similar declines were felt in other indexes and stock markets around the world. These
declines shocked both businesses and investors. In just 24 hours, many people and firms found themselves much less
wealthy. The public began to worry that banks and other financial institutions—to protect their own
loans and investments—would call in borrowers’’ existing loans and stop making new ones. A sharp drop in available credit
could, conceivably, plunge the economy into a deep recession.
Alan Greenspan had just become chairman of the Federal Reserve that year. As a sophisticated economist with historical
knowledge of prior financial crises, he recognized the seriousness of the situation. He quickly issued
a public statement in which he said that the Federal Reserve stood ready to provide liquidity to the economy and the
financial system. Banks were told that the Fed would let them borrow liberally. In fact, the Fed provided liquidity to such an
extent that interest rates even fell. As a result of Greenspan’s action, "Black Monday" did not cause a recession in the United
States.
-The dramatic drop in stock values on October 19, 1987, known as "Black Monday," was potentially catastrophic for the economy because:

• A) the federal government found itself on the brink of default, so ruining millions of public debt holders.
• B) the Fed could not execute any open market operations and the required reserve ratio had been set too low by the previous administration.
• C) the value of the U.S. dollar was likely to fall too and that would create a massive trade deficit.
• D) banks and financial institutions might have called in existing loans and stop making new ones.

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