A Simple Model of An International Lender of Last Resort
IMF Working Papers, April 1, 2000
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- A Simple Model of An International Lender of Last Resort
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Bibliographic details
- Authors: Haizhou Huang, C. A. E. Goodhart
- Published: April 1, 2000
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451849721.001
Summary
- This paper develops a simple model of an international lender of last resort (ILOLR).
- The world economy consists of many open economies, each with a banking system and a central bank operating under a pegged exchange rate regime.
- The fragility of the banking system and the limited ability of a domestic central bank to provide international liquidity together can cause currency and banking crises.
- An international interbank market can help an economy with the needed international liquidity, but with potential costs of international financial contagion.
- An ILOLR can play a useful role in providing international liquidity and reducing international contagion.
Model setup and mechanisms
- World structure:
- Many open economies.
- Each economy has a banking system and a central bank.
- Exchange rate regime: pegged exchange rate.
- Key drivers of crises:
- Fragility of the banking system.
- Limited ability of a domestic central bank to provide international liquidity.
- Liquidity channels:
- International interbank market can supply needed international liquidity.
- International interbank market can also transmit international financial contagion.
- Role of ILOLR:
- Provide international liquidity where domestic central banks are constrained.
- Reduce the risk and spread of international contagion.
Policy implications and recommendations
- Consider establishing mechanisms for international liquidity provision to economies operating under pegged exchange rate regimes when domestic central banks face international liquidity constraints.
- Recognize trade-offs between international interbank market benefits (liquidity provision) and costs (potential contagion).
- Use an ILOLR framework to contain banking and currency crises by directly supplying international liquidity and mitigating contagion across borders.
Content in this bundle
- A Simple Model of an International Lender of Last Resort - WP/00/75