Lender of Last Resort

What Is Lender of Last Resort?

A lender of last resort is an institution — typically a central bank — that stands ready to provide emergency funding to banks and markets during a financial panic, when no one else will lend. By supplying liquidity against collateral, it aims to stop temporary cash shortages from turning solvent institutions into failed ones and to keep panic from cascading through the system. The concept is central to crisis economics. In their landmark study A Monetary History of the United States, economists Milton Friedman and Anna Schwartz argued that the Federal Reserve's failure to act as lender of last resort during the bank panics of 1930-1933 deepened and prolonged the Great Depression.

Why It Matters

The role matters because how forcefully a central bank plays it can shape whether a shock becomes a catastrophe. In the Great Depression the Fed largely stood aside and the money supply collapsed. By contrast, the day after the 1987 Black Monday crash, the Fed publicly affirmed its readiness to serve as a source of liquidity to the financial system, helping markets stabilize without a recession. In 2008 and again in 2020, the Fed deployed vast emergency lending facilities to backstop banks, money markets, and even corporate credit. Ben Bernanke, a scholar of the Depression, cited those historical lessons in justifying the aggressive 2008 response.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• Which two economists co-authored "A Monetary History of the United States," arguing the Federal Reserve's failure to act as lender of last resort deepened the Depression?
  Milton Friedman and Anna Schwartz
• Economists studying the Great Depression often cite the Federal Reserve's failure to expand the money supply during bank panics as an example of what kind of policy failure?
  Failure to act as lender of last resort