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Limited Commitment and Central Bank Lending

By Marvin Goodfriend, Jeffrey M. Lacker, Bob Hetzel, John Walter and John Weinberg

Abstract

Central bank lending is widely regarded as a vital part of the public safety net supporting the stability of the banking system and financial markets. An independent central bank can provide liquidity to financial institutions on very short notice. 1 Indeed, central bank lending has been a prominent part of regulatory assistance to troubled financial institutions in recent years. The idea of a central bank as lender of last resort, however, has been around at least since Walter Bagehot wrote about it over 100 years ago. 2 For most of that time it was taken for granted that central bank lending had benefits with little or no cost. In the past decade, that view has been challenged. For instance, in the United States the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 recognized that Federal Reserve lending to undercapitalized banks has the potential to impose higher resolution costs on the Federal Deposit Insurance Corporation (FDIC). More recently, the idea that lending by the International Monetary Fund has led to increased risk-taking in international financial markets is being taken seriously by financial marke

Year: 2011
OAI identifier: oai:CiteSeerX.psu:10.1.1.199.7240
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