Working Paper: CEPR ID: DP18041
Authors: Charles Goodhart; Rosa Lastra
Abstract: In this paper we revisit the Lender of Last Resort (LOLR) function of the central bank and the associated moral hazard incentives. We argue that, from an economic perspective, the strict application of penalties to the operation of LOLR actions can make that instrument unworkable. Instead, we suggest that both penalties and publication should only be applied after such LOLR had been in place for a time. Normative frameworks ought to be adjusted in this regard.
Keywords: lenderoflastresort; illiquidity; insolvency; stigma
JEL Codes: E5; E58; E59; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strict penalties applied to LOLR actions (G28) | LOLR function becomes unworkable (G33) |
| timing of penalties and publications (C41) | perception and behavior of financial institutions during crisis (G21) |
| stigma associated with LOLR operations (E44) | delayed responses in liquidity crises (E44) |
| limited liability of executives and directors (G33) | moral hazard in financial institutions (G21) |