12.4 Lender of Last Resort #Notebook

12.4 Lender of Last Resort #Notebook

Financial panics and deleveraging can cause firms to reduce output and employment. 

Lenders often try to stop panics and deleveraging by adding liquidity or attempting to restore investor confidence. 

They add liquidity by increasing the money supply, reducing interest rates, and making loans to worthy borrowers.

They try to restore investor confidence by making upbeat statements or by implementing helpful policies.

During the darkest days of 1933, the U.S. federal government restored confidence in the banking system by creating the Federal Deposit Insurance Corporation.

A big event on October 19, 1987, in a single day, the S&P fell by 20%...

The macroeconomic outlook during the months leading up to the crash had become somewhat less certain. . . . 

A growing U.S. trade deficit and decline in the value of the dollar were leading to concerns about inflation and the need for higher interest rates in the U.S. as well. 

As prices dropped, fueling further selling....

To restore confidence, the most common form of lender of last resort today is the government central bank, the Federal Reserve....

The Federal Reserve Chairman Alan Greenspan restored confidence in the stock market by promising to make loans to banks exposed to brokers hurt by the steep decline in stock prices. 

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.