The Lender of Last Resort in a General Equilibrium Framework

46 Pages Posted: 21 Oct 2017 Last revised: 24 Oct 2017

See all articles by Akshay Kotak

Akshay Kotak

Systemic Risk Centre, LSE

Han N. Ozsoylev

Ozyegin University - Faculty of Business

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Date Written: October 15, 2017

Abstract

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

Kotak, Akshay and Ozsoylev, Han N. and Tsomocos, Dimitrios P., The Lender of Last Resort in a General Equilibrium Framework (October 15, 2017). Saïd Business School WP 2017-18, Available at SSRN: https://ssrn.com/abstract=3056389 or http://dx.doi.org/10.2139/ssrn.3056389

Akshay Kotak (Contact Author)

Systemic Risk Centre, LSE ( email )

Houghton St London WC2A 2AE United Kingdom

Han N. Ozsoylev

Ozyegin University - Faculty of Business ( email )

Kusbakisi Cd. No: 2
Altunizade, Uskudar
Istanbul, 34662
Turkey

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

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