Guarantor of Last Resort
49 Pages Posted: 12 Sep 2018
Date Written: September 10, 2018
The optimal response to a financial crisis entails addressing two, often conflicting, demands: stopping the panic and starting the clock. When short-term depositors flee, banks can be forced to sell assets at fire-sale prices, causing credit to contract and real economic activity to decline. To reduce these adverse spillover effects, governments routinely intervene to stop systemic runs. All too often, however, they deploy stopgap measures that allow the underlying problems to fester. To promote long-term economic health, policymakers must also ferret out the underlying problems and allocate the losses that cannot be avoided. An appropriately designed guarantor of last resort can address these conflicting demands. Just-in-time guarantees keep private capital in the system, providing policymakers the time that they need to develop a viable plan to address deficiencies. A strict time limit on those guarantees ensures that policymakers and market participants remain motivated to devise such a plan, avoiding the alternative pitfall of excessive forbearance.
Keywords: financial crises, central banking, financial regulation, regulatory structure, crisis management, forbearance
JEL Classification: E44, G20, G21, G23, G28, H11, H12
Suggested Citation: Suggested Citation