Solvency as a Fundamental Constraint on LOLR Policy for Independent Central Banks: Principles, History, Law

Sir Paul Tucker ()
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Sir Paul Tucker: YPFS, Yale School of Management, https://elischolar.library.yale.edu/journal-of-financial-crises/

Journal of Financial Crises, 2020, vol. 2, issue 2, 1-33

Abstract: This paper follows up earlier work advocating a principled modernization of doctrines for central bank lender-of-last-resort policies and operations. It argues for a new Fundamental Constraint on such authorities: namely, "the principle that central banks should not lend to firms that they know (or should know) to be fundamentally bust or broken." Tucker supports this with commentary from various peers, a review of principles underlying bankruptcy law and resolution schemes, and by deconstructing other common counterarguments. Centrally, he argues that when central banks breach the Fundamental Constraint, they distribute resources to short-term creditors at the expense of longer-term creditors, acting as though they are the elected fiscal authority, and so violating some of the deepest values of constitutional democracy as well as jeopardizing their own independence. Using examples from canonical 19th century crises and the Lehman episode during 2008/09 Great Financial Crisis, he illustrates how the Fundamental Constraint can help make sense of certain decisions, and how it should shape a re-articulation of the published policies of the Federal Reserve and European Central Bank.

Keywords: LOLR; solvency, lehman, independent central bank, federal reserve, bagehot, bank of england (search for similar items in EconPapers)
JEL-codes: G01 G28 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:ysm:ypfsfc:2211

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