Question

• Explain the issues involved with the Fed acting as a Lender of Last Resort (LLR).
• Explain the concept of Moral hazard and its impact

Answer 1

Critics of the tradition of getting a lender of last resort argue that it motivates banks to take excessive chances with the money of consumers, believing that they can be bailed out in a crisis. Such statements were confirmed when, in the aftermath of the 2008 financial crisis, major financial firms, such as Bear Stearns and American International Group , Inc., were bailed out. Proponents state that the likely effects of not getting a last resort lender are much more risky than banks' unnecessary risk-taking.

One challenge that emerges for a last-resort internationsl lender is that it recognises that the developing market country will suffer serious poverty and potential political turmoil if it does not come to the rescue. Politicians in a country of crisis can leverage These worries and engaged in a game of chicken with the last resort international lender: they are refusing the requisite changes, hoping that the last resort international lender can cave in.