Credit policy in times of financial distress

Costas Azariadis

No 23, Special Conference Papers from Bank of Greece

Abstract: This essay evaluates two central bank policy tools, capital requirements and lending of last resort, designed to avert financial panics in the context of endowment economics with complete markets and limited borrower commitment. Credit panics are self-fulfilling shocks to expected credit conditions which cause transitions from an optimal but fragile steady state to a suboptimal state with zero unsecured credit. The main findings are: (i) Countercyclical reserve policies protect the optimum equilibrium against modest shocks but are powerless against large shocks. (ii) If we ignore private information and central banks inefficiencies, this class of models bears out Bagehot’s 1873 claim in Lombard Street: panics are averted if central banks stand ready to lend at a rate somewhat above the one associated with the optimal state.

Keywords: bank panics; last resort; capital requirements; credit conditions (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 (search for similar items in EconPapers)
Pages: 30
Date: 2013-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-ias, nep-mac and nep-mon
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Journal Article: Credit Policy in times of Financial Distress (2014)
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