EconPapers    
Economics at your fingertips  
 

Rediscounting Under Aggregate Risk with Moral Hazard

James Chapman () and Antoine Martin ()

Staff Working Papers from Bank of Canada

Abstract: Freeman (1999) proposes a model in which discount window lending and open market operations have different effects. This is important because in most of the literature, these policies are indistinguishable. However, Freeman's argument that the central bank should absorb losses associated with default to provide risk-sharing stands in stark contrast to the concern that central banks should limit their exposure to credit risk. We extend Freeman's model by introducing moral hazard. With moral hazard, the central bank should avoid absorbing losses and Freeman's argument breaks down. However, we show that policies resembling discount window lending and open market operations can still be distinguished in this new framework. The optimal policy is for the central bank to make a restricted number of creditors compete for funds. By restricting the number of agents, the central bank can limit the moral hazard problem. By making them compete with each other, the central bank can exploit market information that reveals the state of the economy.

Keywords: Payment clearing and settlement systems; Financial markets; Central bank research (search for similar items in EconPapers)
JEL-codes: E58 G20 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2007
New Economics Papers: this item is included in nep-cba and nep-mac
References: Add references at CitEc
Citations: View citations in EconPapers (3) Track citations by RSS feed

Downloads: (external link)
https://www.bankofcanada.ca/wp-content/uploads/2010/02/wp07-51.pdf

Related works:
Journal Article: Rediscounting under Aggregate Risk with Moral Hazard (2013) Downloads
Journal Article: Rediscounting under Aggregate Risk with Moral Hazard (2013) Downloads
Working Paper: Rediscounting under aggregate risk with moral hazard (2007) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:07-51

Access Statistics for this paper

More papers in Staff Working Papers from Bank of Canada 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada. Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2021-11-03
Handle: RePEc:bca:bocawp:07-51