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A Monetary Equilibrium with the Lender of Last Resort

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  • Tarishi Matsuoka
  • Makoto Watanabe

Abstract

This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of a bank’s monetary reserves (a liquidity crisis) occurs endogenously. We show that discount window lending by the LLR is welfare-improving but reduces banks’ ex-ante incentive to hold monetary reserves, which increases the probability of a liquidity crisis, and can cause moral hazard in capital investment. We also analyze the combined effects of monetary and extensive LLR policies, such as a nominal interest rate, a lending rate, and a haircut.

Suggested Citation

  • Tarishi Matsuoka & Makoto Watanabe, 2023. "A Monetary Equilibrium with the Lender of Last Resort," CESifo Working Paper Series 10439, CESifo.
    • Handle: RePEc:ces:ceswps:_10439
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    References listed on IDEAS

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    More about this item

    Keywords

    monetary equilibrium; liquidity crisis; lender of last resort; moral hazard;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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