The Lender of Last Resort in a General Equilibrium Framework
46 Pages Posted: 21 Oct 2017 Last revised: 24 Oct 2017
Date Written: October 15, 2017
This paper models the role of the lender of last resort (LoLR) in a general equilibrium framework. We allow for heterogeneous agents and a risk-averse banking sector, and incorporate the frictions of endogenous default, liquidity, and money. Adverse supply shocks in monetary endowments trigger default, leading to deterioration in the value of bank assets, and subsequent bank illiquidity in some states of the world. LoLR intervention is then assessed with regards to its economy-wide effect on welfare, bank profitability, and the level of default. The results provide a rationalisation for constructive ambiguity and the ‘too big to fail’ problem.
Keywords: lender of last resort, default, bank bailouts, constructive ambiguity
JEL Classification: E58, G21, G28
Suggested Citation: Suggested Citation