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A Monetary Equilibrium with the Lender of Last Resort

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  • Makoto WATANABE
  • Tarishi Matsuoka

Abstract

This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of a banks monetary reserves (a liquidity crisis) occurs endogenously. We show that discount window lending by the LLR is welfare improving but reduces banks ex-ante incentive to hold monetary reserves, which increases the probability of a liquidity crisis, and can cause moral hazard in capital investment. We also analyze the combined effects of monetary and extensive LLR policies, such as a nominal interest rate, a lending rate, and a haircut. Keywords : Monetary Equilibrium, Liquidity Crisis, Lender of Last Resort, Moral Hazard JEL Classification Number : E40

Suggested Citation

  • Makoto WATANABE & Tarishi Matsuoka, 2023. "A Monetary Equilibrium with the Lender of Last Resort," CIGS Working Paper Series 23-010E, The Canon Institute for Global Studies.
    • Handle: RePEc:cnn:wpaper:23-010e
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    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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