Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard?

Antoine Martin

No RWP 01-05, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In this paper I ask whether a central bank policy of providing liquidity to banks during panics can prevent bank runs without causing moral hazard. This kind of policy has been widely advocated, most notably by Bagehot (1873). To analyze such a policy, I build a model with three key features: 1) bank panics can occur in equilibrium, 2) there can be moral hazard, 3) the central bank can create money which is willingly held. I show that a particular central bank repurchase policy provides liquidity to the banking system and can prevent bank panics without moral hazard problems. I also show that a deposit insurance policy, while preventing runs, creates moral hazard problems.

Keywords: Deposit insurance; Liquidity (Economics) (search for similar items in EconPapers)
Date: 2001
New Economics Papers: this item is included in nep-dge, nep-mon and nep-rmg
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Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard (2006)
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