Financial Crises, Payment System Problems, and Discount Window Lending
J. OF MONEY, CREDIT, AND BANKING, Vol. 28 No. 4, November 1996
Posted: 13 May 1998
In a developed economy, financial crises are rapidly conveyed to the payment system, which tends to rely on private credit extensions in most countries. While many authors recommend that the central bank do no more than provide adequate aggregate liquidity during a crisis, this policy requires well-functioning private credit markets to channel liquidity to "solvent, but illiquid" firms. This paper presents a model of private lending which defines a crisis as a tiime when lenders become uncertain about how to assess financial risks, and therefore rationally withdraw from making new loans. In such an environment, a government lender of last resort can improve social welfare.
JEL Classification: G23
Suggested Citation: Suggested Citation