Reserves and the Buyer of Last Resort

Frederic Boissay and Harald Uhlig

No 21837, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We examine the role of central bank reserves and public liquidity when secondary markets may freeze. Central bank reserves help intermediaries purchase assets during stress but crowd out investment. Under laissez-faire, intermediaries hold insufficient reserves, overlooking how aggregate liquidity reduces freeze risk. We propose a ``market-backstop principle", akin to Bagehot’s principle for intermediaries. It combines state-contingent buyer-of-last-resort interventions to restore trading with modest liquidity requirements to limit moral hazard. The welfare benefits of restoring market functioning exceed the fiscal costs of interventions. We explore implications for the size and composition of central bank balance sheets.

Keywords: Public; liquidity (search for similar items in EconPapers)
JEL-codes: E44 E58 G01 G21 (search for similar items in EconPapers)
Date: 2026-08
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