How Central Banks End Crises

Guillermo Ordonez and Gary Gorton
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Gary Gorton: Yale School of Management

No 356, 2016 Meeting Papers from Society for Economic Dynamics

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.

Date: 2016
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cse and nep-mon
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Working Paper: How Central Banks End Crises (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:356

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