The Global Crisis has stirred up a debate on the constraints and boundaries of lender of last resort (LOLR) policies. This column examines the history of the development of the LOLR throughout the world. The LOLR is a locus of political power, and as such, its creation should be viewed as the outcome of a political bargain. It is therefore not surprising that countries differed in their propensity to create LOLRs, and in the powers with which they chose to endow them.
Our historical account shows that differences in the structure and function of lenders of last resort reflect major political obstacles to establishing LOLRs and adopting effective rules for LOLR policy, and cannot be explained by economic differences alone. This was the case in early 19th century Britain, where the institutional changes that gave the Bank of England LOLR powers and responsibilities, following a succession of banking crises, were controversial and contested. In the US, the development of a LOLR was delayed as a result of political opposition, and when the Federal Reserve System was created in 1913, its structure and powers were circumscribed by restrictive legislation. The Fed’s powers were narrowly confined to engaging in collateralised rediscounts and advances on certain classes of assets with member banks. In contrast, the Bank of England was permitted ample room for improvisation.
The experiences of Canada and Australia also illustrate unique central bank chartering outcomes, which reflect their own political histories. Canada’s classically liberal political environment eschewed central banking until 1935. Instead, Canada relied on interbank coordination to avoid banking crises. The establishment of the Bank of Canada in 1935 reflected monetary goals rather than any perceived failings due to the absence of a LOLR. Australia did not create a full-fledged central bank until 1959, which was the culmination of a protracted political struggle over the appropriate allocation of power over money and credit. More recently, political constraints that reflect the allocation of political powers within the euro area have played an important role in defining and limiting LOLR actions of the ECB to deal with banking crises within the euro area.
The LOLR is a locus of political power, and as such, its creation should be viewed as the outcome of a political bargain (Calomiris and Haber 2014). It is therefore not surprising that countries differed in their propensity to create LOLRs, and in the powers with which they chose to endow them. LOLRs began as collateralised lenders empowered and required to provide credit to banks that were otherwise unable to fund their needs during crises, but LOLRs’ statutory powers changed over time in varied ways.
We trace changes over time in the approaches used by central banks and governments to deal with financial crises from the late 19th century to the late 20th century. We identify a shift in the scope of LOLRs away from a narrow reliance on collateralised lending to an approach including also other forms of support, including credit guarantees, preferred stock assistance, and other mechanisms. We relate this shift in part to the need to expand LOLR activity to a broader set of interventions in the case of systemic banking crises.
Prof. Calomiris has been talking about the political linkages to finance for a while now..