How Central Banks End Crises

Gary Gorton () and Guillermo Ordoñez ()
Additional contact information
Gary Gorton: Yale School of Management, National Bureau of Economic Research
Guillermo Ordoñez: Department of Economics, University of Pennsylvania, National Bureau of Economic Research
Authors registered in the RePEc Author Service: Guillermo L. Ordonez

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: To end a financial crisis, the central bank is to lend freely, against good collateral, at a high rate, according to Bagehot’s Rule. We argue that in theory and in practice there is a missing ingredient to Bagehot’s Rule: secrecy. Re-creating confidence requires that the central bank lend in secret, hiding the identities of the borrowers, to prevent information about individual collateral from being produced and to create an information externality by raising the perceived value of average collateral. Ironically, the participation of "bad" borrowers, with low quality collateral, in the central bank’s lending program is a desirable part of re-creating confidence because it creates stigma. Stigma is critical to sustain secrecy because no borrower wants to reveal his participation in the lending program, and it is limited by the central bank charging a high rate for its loans.

Keywords: Central Bank; Discount Window; Financial Crisis; Confidence (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2014-09-02
New Economics Papers: this item is included in nep-cba, nep-cta, nep-hpe, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: How Central Banks End Crises (2016)
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