A Model of the Lender of Last Resort

IMF Working Papers, March 1, 1999

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A Model of the Lender of Last Resort

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Bibliographic details

• Authors: Haizhou Huang, C. A. E. Goodhart
• Published: March 1, 1999
• Series: IMF Working Papers

Summary and key results

• 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:
  • 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, scope, and terminology

• 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

Content in this bundle

• A Model of the Lender of Last Resort - WP/99/39
  • A Model of the Lender of Last Resort - WP/99/39 (Markdown version)
  • A Model of the Lender of Last Resort - WP/99/39 (PDF)