A Modern Approach to the Classical Theory of the Lender of Last Resort

Speaker: Professor Fabrizio Mattesini 
Affiliation: The University of Rome “Tor Vergata”
Location: Room S402, Social Sciences Building (#24), UQ St Lucia Campus 

Abstract 

The classical theory of the lender of last resort (Thornton 1802 and Bagehot 1873) emphasizes that the lender: support financial markets and not individuals; behave consistently with longer run (inflation) objectives; and lend freely “to this man and that man” on good collateral at a high rate. Importantly, the classical theory stresses that a lender of last resort is a monetary—and not a credit—operation, where the lender’s objective is to get cash into the hands of people that need it and spend it. These days the classical prescriptions are viewed as outdated and anachronistic—perhaps relevant back in the 1800’s but not in today’s complex, modern financial economy. Instead, the lender of last resort should use its balance sheet to pursue credit and interest rate policies that directly affect long term assets and/or rescue large, interconnected and insolvent institutions, ideas that the classical writers fiercely opposed. We use a standard, dynamic monetary model to assess the classical theory and its prescriptions and find that “lending freely at a high rate on good collateral” enhances social welfare if the economy may be hit by severe liquidity shocks. In fact, some recent policies that central banks, e.g., the Federal Reserve, have pursued in response to aggregate liquidity shortages are consistent with the classical theory.

About the presenters meeting 

If you would like to meet with Prof Mattesini contact: Prof Begoña Dominguez.