Bank Panics and the Endogeneity of Central Banking Liquidity, Efficiency, and Bank Bailouts推荐.pdfVIP

10 Bank Panics and the Endogeneity of Central Banking G A RY B. G O RTO N A N D LI X I N H U A N G * 10.1. INTRODUCTION The most important function of a central bank is to provide liquidity to the bank- ing system in times of crisis. The classic work on central banking, Lombard Street, by Walter Bagehot, published in 1877, offered the advice that in times of panic the central bank (Bank of England) should lend freely and continue to pay out currency (Bagehot, 1877). At the time Lombard Street was published, there was no central bank in the US and yet the private arrangement of banks in the US clearinghouse system had already discovered Bagehot’s precepts and was acting on them. In this chapter we argue that the lender-of-last-resort function of “central banking” arose endogenously through the formation of state contingent bank coalitions, such as clearinghouses, which provided liquidity during banking panics. In the model we propose, central banking emerges endogenously as a response to the banking system’s problems of asymmetric information and con- comitant moral hazard. In some banking systems these problems can lead to banking panics. But, these banking panics are not irrational manifestations of multiple equilibria. Rather, these episodes represent depositors monitoring their banks, which are vulnerable to moral hazard problems in certain states of the world. With the information asymmetry, such panics may involve inefficiencies because banks may be mistakenly liquidated. Banks cannot honor the demands * Thanks to Franklin Allen, Eslyn Jean-Baptiste, Michael Bordo, John Boyd, Charles Calomiris, Ed Green, Richard Kihlstrom, Holger Mueller, Ben Polak and to seminar participants at New York University, the Yale Banking Conference, and the F