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Abstract
Without a lender of last resort financial stability is not possible and systemic financial crises get out of control. During and after the Great Recession the US Federal Reserve System (Fed) and the European Central Bank (ECB) took on the role of lender of last resort in a comprehensive way. The Fed stabilised the financial system, including the shadow banking system. However, the chance to fundamentally restructure the financial system was not used. The ECB was confronted with sovereign debt crises and an incomplete integration of the European Monetary Union (EMU). It followed a kind of ?muddling through? to keep the Euro area together. In the EMU not only a fundamental restructuring of the financial system is needed but also a deeper economic and political integration. The Fed and the ECB both were the most important institutions to avoid repetition of the 1930s.
Highlights
The large amount of created Central bank money was not used by the financial system to give credits to the public. Most of it was kept as excess reserves held by financial institutions. This implies that the money creation by the Federal Reserve System (Fed) and the European Central Bank (ECB) did not reach the public via a credit expansion, for example, for investment
Quantitative easing was carried out to such an extent that it compensated the reduction of all special liquidity facilities and even increased the assets held by the Fed substantially
The fundamental changes in the financial systems since the start of the deregulation wave in the 1970s/1980s modified the function of a lender of last resort
Summary
Central banks can provide legal tender and the asset with the highest liquidity. Should be performed by a Central bank; the governance of moral hazard by another institution, the supervisor”; iii) It should lend to any actors with good collateral This principle is difficult to fulfil during a systemic financial crisis. Good collateral quickly becomes bad collateral when asset prices erode; iv) It should lend to illiquid but not to insolvent institutions Behind this idea hides the doctrine that insolvent financial institutions should not be saved by the Central bank. To sum up: During a financial crisis a Central bank should lend comprehensively at low interest rates It should accept poor collateral, and save systemic relevant institutions even if these are insolvent, the owners of such institutions should not be rescued
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