MACRO: A Modern Perspective on the Classical Approach to the Lender of Last Resort; Professor Fabrizio MATTESINI (University of Rome)
Abstract
The classical lender of last resort approach (Thornton 1802 and Bagehot 1873) emphasizes that the lender supports financial markets and not individuals; behave sconsistently with longer run (inflation) objectives; and lends freely "to this man and that man" on good collateral at a high rate. Importantly, the classical approach stresses that a lender of last resort is a monetary - not a credit-operation, where the objective is to get cash into the hands of people that need it. These days the classical prescriptions are seen by some as being outdated and anachronistic-perhaps being relevant back in the 1800Â’s but not in today's complex, modern financial economy. Instead, the lender of last resort should use its balance sheet to pursue credit/interest rate policies that directly affect long term assets and/or rescue large, interconnected and insolvent institutions, things that the classical writers were fearsely opposed to. We use a standard, dynamic monetary model to assess the classical approach and find that "lending freely at a high rate" on good collateral enhances social welfare when the economy is hit by servere liquidity shocks. In fact, the classical approach can be seen in some of the policies pursued by, e.g., the Federal Reserve, in response to aggregate liquidity shortages.
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