A Model of the Lender of Last Resort

March 1, 1999

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Format: Chicago

Haizhou Huang, and C. A. E. Goodhart A Model of the Lender of Last Resort, (USA: International Monetary Fund, 1999) accessed September 20, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a model of the lender of last resort. It provides an analytical basis for “too big too fail” and a rationale for “constructive ambiguity”. Key results are that if contagion (moral hazard) is the main concern, the Central Bank (CB) will have an excessive (little) incentive to rescue banks and the resulting equilibrium risk level is high (low). When both contagion and moral hazard are jointly analyzed, the CB’s incentives to rescue are only slightly weaker than with contagion alone. The CB’s optimal policy may be non-monotonic in bank size.

Subject: Banking, Central banks, Commercial banks, Distressed institutions, Financial crises, Financial institutions, Financial sector policy and analysis, Lender of last resort, Moral hazard, Open market operations

Keywords: Bank size, Banking Crises, CB response, Central bank, Commercial banks, Distressed institutions, Financial Contagion, Lender of Last Resort, LOLR record, LOLR support exercise, Loss function, Moral Hazard, Open market operations, Prompt LOLR action, WP

Publication Details

Pages:

33
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1999/039
Stock No:

WPIEA0391999
ISBN:

9781451845815
ISSN:

1018-5941

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