The Fed as Lender of Last Resort: Comments on "Rules for a Lender of Last Resort" by Michael Bordo

Central bank actions constitute monetary policy if they alter the quantity of the bank’s monetary liabilities. Central bank actions constitute credit policy if they alter the composition of the bank’s portfolio but do not affect the outstanding amount of monetary liabilities. Justifications for the Fed’s financial crisis lending — and its role as “lender of last resort” more generally — seem to misunderstand this distinction. For the most part, the Fed’s lending did not affect its outstanding monetary liabilities, and thus did not represent lender of last resort activity. The central bank’s actions affect market participants’ beliefs about future central bank actions, which in turn affect their incentives to protect themselves against financial distress. Thus, it is likely that financial instability has been induced by a history of government rescues for uninsured creditors. Credible limits to central bank intervention are critical to central banks’ core monetary policy mission. One way to establish such limits is to create “living wills” that detail how to resolve large, complex financial firms without government support.