A Monetary Equilibrium with the Lender of Last Resort

Makoto Watanabe and Tarishi Matsuoka

No 23-010E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of a banks monetary reserves (a liquidity crisis) occurs endogenously. We show that discount window lending by the LLR is welfare improving but reduces banks ex-ante incentive to hold monetary reserves, which increases the probability of a liquidity crisis, and can cause moral hazard in capital investment. We also analyze the combined effects of monetary and extensive LLR policies, such as a nominal interest rate, a lending rate, and a haircut. Keywords : Monetary Equilibrium, Liquidity Crisis, Lender of Last Resort, Moral Hazard JEL Classification Number : E40

Pages: 40
Date: 2023-06
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fdg, nep-mfd and nep-mon
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Working Paper: A Monetary Equilibrium with the Lender of Last Resort (2023)
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