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Coordination failures and the lender of last resort: was Bagehot right after all?

Rochet, Jean-Charles and Vives, Xavier (2002) Coordination failures and the lender of last resort: was Bagehot right after all? Discussion paper, 408. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Identification Number: 408

Abstract

The classical doctrine of the Lender of Last Resort, elaborated by Thornton (1802) and Bagehot (1873), asserts that the Central Bank should lend to “illiquid but solvent” banks under certain conditions. Several authors have argued that this view is now obsolete: when interbank markets are e¢cient, a solvent bank cannot be illiquid. This paper provides a possible theoretical foundation for rescuing Bagehot’s view. Our theory does not rely on the multiplicity of equilibria that arises in classical models of bank runs. We build a model of banks’ liquidity crises that possesses a unique Bayesian equilibrium. In this equilibrium, there is a positive probability that a solvent bank cannot …nd liquidity assistance in the market. We derive policy implications about banking regulation (solvency and liquidity ratios) and interventions of the Lender of Last Resort as well as on the disclosure policy of the Central Bank.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2002 The Authors
Subjects: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 20 Aug 2009 08:55
Last Modified: 27 Feb 2014 15:36
URI: http://eprints.lse.ac.uk/id/eprint/24928

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