Hostname: page-component-76fb5796d-qxdb6 Total loading time: 0 Render date: 2024-04-26T17:32:59.695Z Has data issue: false hasContentIssue false
  • English
  • Français

DISCOUNT WINDOW POLICY, BANKING CRISES, AND INDETERMINACY OF EQUILIBRIUM

Published online by Cambridge University Press:  14 December 2005

GAETANO ANTINOLFI  and
TODD KEISTER
GAETANO ANTINOLFI
Affiliation:
Department of Economics, Washington University
TODD KEISTER
Affiliation:
Centro de Investigación Económica, Instituto Tecnológico Autónomo de México (ITAM)
Get access Rights & Permissions [Opens in a new window]

Abstract

We study how discount window policy affects the frequency of banking crises, the level of investment, and the scope for indeterminacy of equilibrium. Previous work has shown that providing costless liquidity through a discount window has mixed effects in terms of these criteria: It prevents episodes of high liquidity demand from causing crises but can lead to indeterminacy of stationary equilibrium and to inefficiently low levels of investment. We show how offering discount window loans at an above-market interest rate can be unambiguously beneficial. Such a policy generates a unique stationary equilibrium. Banking crises occur with positive probability in this equilibrium and the level of investment is suboptimal, but a proper combination of discount window and monetary policies can make the welfare effects of these inefficiencies arbitrarily small. The near-optimal policies can be viewed as approximately implementing the Friedman rule.

Keywords

Discount Window LendingLiquidity CrisisInvestmentFriedman Rule
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 10 , Issue 1 , February 2006 , pp. 1 - 19
Copyright
© 2006 Cambridge University Press

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Antinolfi Gaetano, Elisabeth Huybens, and Todd Keister 2001 Monetary stability and liquidity crises: The role of the lender of last resort. Journal of Economic Theory 99, 187– 219.Google Scholar
Bagehot Walter 1873 Lombard Street: A Description of the Money Market. London: William Clowes and Sons.
Bhattacharya Joydeep, Joseph H. Haslag, and Steven Russell (in press) The role of money in two alternative models: When is the Friedman rule optimal, and why? Journal of Monetary Economics.
Boyd John H., Sungkyu Kwak, and Bruce D. Smith (in press) The real output losses associated with modern banking crises. Journal of Money, Credit, and Banking.
Champ Bruce, Bruce D. Smith, and Stephen D. Williamson 1996 Currency elasticity and banking panics: Theory and evidence. Canadian Journal of Economics 29, 828– 864.Google Scholar
Diamond Douglas W. and Philip H. Dybvig 1983 Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91, 401– 419.Google Scholar
Ennis Huberto M. and Todd Keister 2003 Economic growth, liquidity, and bank runs. Journal of Economic Theory 109, 220– 245.Google Scholar
Freeman Scott 1996 The payments system, liquidity, and rediscounting. American Economic Review 86, 1126– 1138.Google Scholar
Freeman Scott 1999 Rediscounting under aggregate risk. Journal of Monetary Economics 43, 197– 216.Google Scholar
Haslag Joseph H. and Antoine Martin 2003 Optimality of the Friedman Rule in Overlapping Gene- rations Models with Spatial Separation, Federal Reserve Bank of Kansas City RWP 03-03, June.Google Scholar
Martin Antoine 2002 Reconciling Bagehot with the Fed's Response to Sept. 11, Federal Reserve Bank of Kansas City RWP 02-10, December.Google Scholar
Peck James and Karl Shell 2003 Equilibrium bank runs. Journal of Political Economy 111, 103– 123.Google Scholar
Sargent Thomas J. and Neil Wallace 1982 The real-bills doctrine versus the quantity theory: A reconsideration. Journal of Political Economy 90, 1212– 1236.Google Scholar
Schreft Stacey L. and Bruce D. Smith 2002 The conduct of monetary policy with a shrinking stock of government debt. Journal of Money, Credit, and Banking 34, 848– 882.Google Scholar
Smith Bruce D. 2002 Monetary policy, banking crises, and the Friedman rule. American Economic Review 92, 128– 134.Google Scholar
Smith Bruce D. and Warren Weber 1999 Private money creation and the Suffolk Banking System. Journal of Money, Credit, and Banking 31, 624– 659.Google Scholar
Townsend Robert M. 1987 Economic organization with limited communication. American Economic Review 77, 954– 971.Google Scholar
Williamson Stephen D. 1998 Discount window lending and deposit insurance. Review of Economic Dynamics 1, 246– 275.Google Scholar
Williamson Stephen D. 2003 Payments systems and monetary policy. Journal of Monetary Economics 50, 475– 495.Google Scholar