Working Paper: CEPR ID: DP13556
Authors: Maylis Avaro; Vincent Bignon
Abstract: This paper uses a historical study to show a solution to the trade-off faced by central banks between providing liquidity to a broad group of financial intermediaries and the risk that this easy access may fuel moral hazard. In late 19th century the Bank of France operated a very wide discount window and used a variety of risk management techniques to effectively subdue risk-taking behaviors and to protect its balance sheet from taking any loss. This allowed agents to monetize a very diverse set of capital while limiting the risk of bail-out. We show that this effectively helped the central bank to stabilize the economy from the consequences of negative income shocks.
Keywords: lender of last resort; central bank; discount window; shadow banks
JEL Codes: E51; G23; N13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| design of the discount window (E52) | ability to stabilize the economy (E63) |
| operational design of the discount window (E52) | provision of liquidity (G33) |
| provision of liquidity (G33) | stabilization of the economy (E63) |
| monitoring risk appetite (G41) | discrimination between risk-averse and risk-taking agents (D81) |
| discrimination between risk-averse and risk-taking agents (D81) | maintenance of financial stability (G28) |
| design of the discount window (E52) | mitigation of moral hazard (G52) |
| mitigation of moral hazard (G52) | success in stabilizing the economy (E63) |