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Liquidity Crises and the Market-Maker of Last Resort

Author

Listed:
  • Charles Kahn
  • David Marshall
  • Robert L. McDonald

Abstract

We study market illiquidity in an economy subject to non-fundamental shocks. Asset trading occurs via decentralized one-on-one bargaining. The model has multiple rational expectations equilibria; we associate certain Pareto inferior equilibria with liquidity crises. The government can improve welfare by acting as a “market-maker of last resort” (MMLR), purchasing assets at above-market prices. Several policies employed by the US during the financial crisis are examples of MMLR. We consider “aggressive” and “conservative” MMLR policies. The aggressive policy supports the unique pareto optimal equilibrium. The conservative policy, which embeds a “no-bailout constraint,” only supports an inefficient equilibrium.

Suggested Citation

  • Charles Kahn & David Marshall & Robert L. McDonald, 2025. "Liquidity Crises and the Market-Maker of Last Resort," NBER Working Papers 33587, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33587
    Note: CF ME
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    More about this item

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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