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
  • A Simple Model of an International Lender of Last Resort - WP/00/75 (Markdown version)
  • A Simple Model of an International Lender of Last Resort - WP/00/75 (PDF)