Who Should Act as Lender of Last Resort? An Incomplete Contracts Model
Journal of Money, Credit and Banking, Vol. 32, No. 3, Part II, August 2000 "What Should Central Banks Do?: A conference sponsored by the Federal Reserve Bank of Cleveland, Oct. 27-29, 1999, Joseph G. Haubrich, Special Issue Editor"
Posted: 26 Oct 2000
This paper presents a model of a bank subject to liquidity shocks that require borrowing from a lender of last resort. Two government agencies may perform this function: a central bank and a deposit insurance corporation. The agencies share supervisory information, which provides a nonverifiable signal of the bank's financial condition, and use it to decide whether to support it. It is shown that the optimal institutional design involves the two agencies: the central bank dealing with small liquidity shocks, and the deposit insurance corporation with large shocks. Furthermore, except for very small shocks, they should lend at penalty rates.
JEL Classification: E58, G21, G28
Suggested Citation: Suggested Citation