Chapter 14: Executive Summary – Private Lessons for Public Banking: The Case for Conditionality in LOLR Facilities
From the book “Restoring Financial Stability: How to Repair a Failed System”. Section V: The Role of the Fed
As we work our way through the current financial crisis, central banks have shifted their attention from managing short-term interest rates to providing liquidity to the financial system. In the US, for example, the Federal Reserve’s balance sheet has expanded rapidly, as it offered funds to banks and accepted securities in return: from under a trillion dollars in August 2007 to over two trillion in November 2008, expanding primarily through its lending to banks against illiquid collateral. This “lender of last resort” (LOLR) role is neither new nor unusual, but its massive scale suggests that it is worth some thought to get the details right. We make below what may seem right now to be a perverse argument: Central banks can learn something from the private sector about how to manage its provision of liquidity.