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Central Bank Balance Sheets, LOLR Safety Nets, and Moral Hazard

Summary:
Niall Ferguson, Martin Kornejew, Paul Schmelzing and Moritz Schularick in CEPR dp 17858: From the introduction: … time and again, central banks deployed their power to create liquidity in a bid to insulate economies from disasters. … first began to be linked to geopolitical tail events during the 17th and 18th centuries – occurring with increasing regularity during wars and revolutions –, … the context of central bank liquidity support gradually but consistently shifted towards financial crises: … central banks’ sensitivity to financial crises has risen sharply over the 20th century and increasingly became a systematic response to financial distress after the Great Depression. … … central bank liquidity support systematically cushioned economic effects of financial

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Niall Ferguson, Martin Kornejew, Paul Schmelzing and Moritz Schularick in CEPR dp 17858:

Central Bank Balance Sheets, LOLR Safety Nets, and Moral Hazard

Central Bank Balance Sheets, LOLR Safety Nets, and Moral Hazard

Central Bank Balance Sheets, LOLR Safety Nets, and Moral Hazard

From the introduction:

… time and again, central banks deployed their power to create liquidity in a bid to insulate economies from disasters. … first began to be linked to geopolitical tail events during the 17th and 18th centuries – occurring with increasing regularity during wars and revolutions –, … the context of central bank liquidity support gradually but consistently shifted towards financial crises: … central banks’ sensitivity to financial crises has risen sharply over the 20th century and increasingly became a systematic response to financial distress after the Great Depression.

… central bank liquidity support systematically cushioned economic effects of financial crises throughout modern history of advanced economies. …

Historically, central bank liquidity support in crises is associated with a rising probability of future episodes of excessive risk-taking by financial intermediaries that end in another financial crisis. If central banks refrained from using their balance sheet to support markets in the last crisis, episodes of renewed excessive risk taking are much rarer.

Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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