The Lender of Last Resort in a General Equilibrium Framework

Akshay Kotak, Han Ozsoylev and Dimitrios Tsomocos

Chapter 5 in Financial Regulation and Stability, 2019, pp 113-157 from Edward Elgar Publishing

Abstract: This paper models the role of the lender of last resort (LoLR) in a general equilibrium framework. We allow for heterogeneous agents and a risk-averse banking sector, and incorporate the frictions of endogenous default, liquidity, and money. Adverse supply shocks in monetary endowments trigger default, leading to deterioration in the value of bank assets, and subsequent bank illiquidity in some states of the world. LoLR intervention is then assessed with regards to its economy-wide effect on welfare, bank profitability, and the level of default. The results provide a rationalization for constructive ambiguity and the ‘too big to fail’ problem.

Keywords: Economics and Finance (search for similar items in EconPapers)
Date: 2019
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