Limited Commitment and Central Bank Lending

27 Pages Posted: 26 Nov 2012

See all articles by Marvin Goodfriend

Marvin Goodfriend

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Jeffrey M. Lacker

Federal Reserve Bank of Richmond

Multiple version iconThere are 2 versions of this paper

Date Written: 1999

Abstract

This consideration of central bank lending as a publicly provided line of credit begins by describing how private line-of-credit contracts control moral hazard and limit lending to insolvent borrowers. The fundamental problem for a central bank is to credibly commit to limit its lending. Failure to do so creates moral hazard with adverse consequences. Of five candidate approaches to the commitment problem – namely, good offices only, collateral and early intervention, constructive ambiguity, extended supervisory and regulatory reach, and building a reputation for not lending – only the last will work in practice. Lessons from the historical acquisition of credibility for low inflation suggest a particular scenario by which a central bank could gradually acquire a reputation for limiting its lending commitment.

Suggested Citation

Goodfriend, Marvin and Lacker, Jeffrey M., Limited Commitment and Central Bank Lending (1999). FRB Richmond Economic Quarterly, vol. 85, no. 4, Fall 1999, pp. 1-27. Available at SSRN: https://ssrn.com/abstract=2129867

Marvin Goodfriend

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jeffrey M. Lacker (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8279 (Phone)
804-697-8461 (Fax)

HOME PAGE: http://www.richmondfed.org

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