Discount Window Policy, Banking Crises, and Indeterminacy of Equilibrium

Posted: 16 Feb 2013

See all articles by Gaetano Antinolfi

Gaetano Antinolfi

Washington University in St. Louis - Department of Economics

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: 2006

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 Lending, Liquidity Crisis, investment, Friedman Rule

JEL Classification: E31, E42, E58, G21

Suggested Citation

Antinolfi, Gaetano and Keister, Todd, Discount Window Policy, Banking Crises, and Indeterminacy of Equilibrium (2006). Macroeconomic Dynamics, Vol. 10, No. 1, 2006, Available at SSRN: https://ssrn.com/abstract=2218557

Gaetano Antinolfi

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States
314-935-7335 (Phone)
314-935-4156 (Fax)

Todd Keister (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://www.toddkeister.net/

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